Investment services offered to individual investors come in a myriad of packaging and delivery options. Discount brokerage houses, full-service brokerage houses, load mutual fund firms, no-load mutual fund firms, banks, insurance companies, private money management firms and fee-based advisors all attempt to convince investors that they are the best available alternative. Yet, despite their different packaging they are each providing all or part of the same three primary value components - advice, portfolio management and administration.
Advice is the process of defining and implementing an appropriate investment strategy given an investor's objectives and particular constraints. Portfolio management is the process of building and maintaining an investment portfolio that properly addresses the strategy the advisory component has defined. Administration is all the trading, clearing and reporting functions required to effectively execute the portfolio management process.
This article will take a closer look at the subcomponents within each of the three broad value components and show you how to use them to analyze which parts of the financial management process are worth paying for, and which you may want to take on yourself.
Of the three components, administration is the one that you will be least able to do on your own. Any registered broker/dealer has access to many equity, fixed-income and commodities markets through which they can buy and sell. For a host of reasons, you are not able to go directly to these markets yourself. As such, this is a subcomponent that you will have to outsource and pay for in the form of some fee or commission. Fortunately, with online discount brokerages, the costs associated with trading are minimal. In addition, these costs cover trade settlement, confirmations, and other client statements, all of which are in compliance with mandated regulations. There are some other administrative services, however, that are not automatically supplied by your brokerage firm.
While year-end reporting for tax purposes is required, not all brokerage firms track cost basis for you. This is something you can do yourself with a spreadsheet or even a notepad, but depending on the number of holdings you have it can be a time-intensive. In choosing a brokerage firm, try to find one that keeps accurate track of your cost basis. It will save you time when you prepare your tax returns each year. (For more insight, read How do I figure out my cost basis on a stock investment?)
Another important administration function you can handle yourself is performance reporting. Truly accurate reporting, however, will be almost impossible without some fairly sophisticated software that keeps track of all cash flows and is able to calculate time-weighted total rate of return. If your brokerage firm can do this for you at no additional charge, you are receiving a material increase in value.
Most investors, and sadly most investment advisors, have little training or knowledge regarding security analysis and portfolio management. Typically, investor portfolios are built in a hodge-podge manner over time. Securities are chosen without benefit of in-depth analysis and without proper regard as to how they interrelate with one another. Holdings are often spread over numerous accounts held at various locations so there is little way to determine how the overall investment portfolio is performing.
Proper security analysis is required to identify suitable and attractive investments. The level of expertise needed varies between investment types. Stock analysis can be fairly straightforward, but many fixed-income investments incorporate a variety of factors that must be carefully considered. Derivatives, options, futures and commodities are even more complex. Without extensive training, you may find it extremely difficult to ascertain fair value of the many varied security options available. On top of the security selection requirements, you must understand how these individual securities act in concert to form an efficient and effective portfolio. At a minimum, you will need to understand some of the core principles of modern portfolio theory (MPT).
Unfortunately, most retail investment advisors have little training in security selection and overall portfolio management. Base licensing requirements are far from in-depth. Various "professional" designations abound, but many are rudimentary at best. The preeminent professional designation for portfolio management is the Chartered Financial Analyst (CFA). The CFA is nearly a requirement if one wishes to be a security analyst or portfolio manager on Wall Street. It is an intensive and comprehensive training program that takes a minimum of three years to complete. Few retail investment advisors hold the CFA and individual investors do not even have access to the program. (For more insight, read The Alphabet Soup Of Financial Certifications.)
You can create and manage an effective investment portfolio without a CFA designation of your own or a CFA acting as your advisor, but it may be more challenging than you think. You could find that you gain more than you lose by outsourcing this particular value component. (For more insight, see Manage My Own Investments? Are You Kidding?)
Serving as your own investment advisor may be the easiest of the three value components to do yourself. Still, a host of constantly changing factors involving not only investments, but also taxes, insurance needs, liquidity needs, and other special needs or constraints must be addressed.
Resources for financial advice are plentiful. A multitude of books, magazines, web sites, blogs, and organizations churn out tons of valuable information covering almost every aspect of financial planning. With time and effort, there is no reason to believe that reasonably intelligent investors can't serve adequately as their own investment advisors. The key consideration should therefore be the desire to do so. Laws and regulations are constantly in flux. Staying abreast of these changes and adjusting your plan accordingly can be time consuming. If you have the time and desire it can be done, but you may find that you would prefer some help. (For more, see Tailoring Your Investment Plan.)
If you do decide you want the assistance of a professional advisor, your key consideration should be value, since pricing for this service is fairly comparable. Once again, base securities license requirements focus on investment alternatives. Comprehensive financial planning is not covered.
Know Your Limitations, Maximize Your Value
When taking on part of the investment process yourself, you must know your limitations. Being a do-it-yourself investor entails much more than picking a stock or selecting a mutual fund. Make an honest assessment of your abilities, available time and level of desire. If you choose to outsource some or all of the components or sub-components, make certain that you maximize your value. Choose advisors who have demonstrated a commitment to learning and excellence. Select portfolio managers with proper training and credentials. Use brokerage firms that provide a full array of comprehensive services. If you follow these basic principles, there is no reason you won't succeed, regardless of whether you do all of it yourself, some of it yourself, or none of it yourself.