Our modern society calls for specialisation ever since Adam Smith talked about the division of labour. We don’t rear and slaughter our own animals. Neither do we grow our food or build our houses. We outsourced them to others who specialised at doing such things while we focus on what we do best.
Most individuals would also outsource their investments to the professionals. But there will always some individuals who aspire to make some profits in the stock market with their own abilities. I would label these individuals who pick and buy stocks on their own accord as DIY stock investors. Investors who buy stock ETFs aren’t counted though.
In this article I want to challenge you to think about the amount of work and the multiple roles you need to perform as a DIY stock investor. Maybe it will make you think twice before embarking on this journey. But if you are inspired by it, you might possess an important ingredient to become a successful DIY stock investor.
A DIY stock investor is a fund manager
A fund manager decides on the mandate of the fund – what to invest in? Where to invest in – by country (US, China, …) or by regions (Europe, Asia, …)? What investment style to adopt – value, growth, …? Any other specific rules such as the size of a position in one stock / bond or any cut loss mechanism when the market turns south?
These are decisions that an DIY investor needs to make as well. He must formulate a set of investment principles that would guide him to decide on the buy, hold and sell actions. It would allow him to act with consistency when evaluating investments.
Unfortunately, many DIY investors do not have a set of principles to rely upon for their investment decisions. They ended up seeking stock tips because that’s the quick and easy way to buy stocks. I remembered a good saying from a well-followed investor, Ian Cassel,
You can borrow someone else’s stock ideas but you can’t borrow their conviction.
Investing is not just about hopping on a hot idea but to stick around even when the market is going against you because you have reasonable conviction why you are right about the stocks you have. I have observed many DIY investors who lack this conviction and the symptom is often obvious – they are at a loss about what to do with their stocks. To make matter worse, they have a rojak portfolio because the stock ideas were gathered through investment tips from various people with diverse investment objectives, timeframes and risk appetites.
Thus, a DIY stock investor needs to perform his role as a fund manager to craft a set of investment principles to guide his investing actions. He can continue to refine these principles over time.
A DIY stock investor is an analyst
The fund manager has no time to look at individual stocks in the portfolio. He relies on his analysts to monitor the stocks in the fund, scout for new stocks, investigate them deeply and to recommend trade ideas to the fund manager. A lot of time is spent gathering information and analysing them. Some may even build models to value the stocks. Analysts are often assigned to a particular industry so that they can develop specialised knowledge to make good assessments of the stocks in it.
A DIY stock investor has to perform the role of an analyst too. He needs to generate trade ideas. This can be done in many ways.
Stock screeners are widely available nowadays and most are free to use. A DIY stock investor with a clear set of principles would find it easy to use a stock screener because he knows what he is looking for and what metrics to filter the stocks.
He can also rely on others for trade ideas – business news, sell-side analyst reports, newsletters, blogs, forums, stock brokers and even friends. But he should not act on them without finding out more. He should dig deeper and not be afraid to discard trade ideas if he found them unsuitable.
Unlike the analysts whereby they can focus on an industry, a DIY stock investor has to learn beyond one industry to ensure his portfolio is diversified. It is too risky to put all your capital into one industry. But most investors aren’t familiar with industries outside the one they worked in and hence, it will take a considerable amount of time and effort to learn about the other industries. Knowing enough is important because the edge comes from developing an insight that most of the market participants fail to see. This is where the investment rewards are.
A DIY stock investor would also need to know how to perform valuations on stocks like the analysts. Even if he is not crunching the numbers or building models, he should know what financial metrics to use and to be able to interpret them – P/E ratio of 10, dividend yield of 5%, EV/EBIT of 33, P/B of 1.2 and many more – what are these telling you? Are they relevant? Are they cheap, expensive or fairly priced?
Hence a DIY stock investor has to read and think a lot. It is hard to sustain this if one has no interest in this field.
A DIY stock investor is a trader
The instructions will be sent to the traders to execute once the fund manager have adopted the analysts’ ideas and have decided on the allocation. The traders will attempt to get the best prices from the market. They will have to survey the supply and demand and make their assessment how best to fill the orders.
A DIY stock investor does not have the luxury of having a trader to do it for him. He has to be the trader himself. But the good news is that the orders are not as huge when trading for an individual. Placing orders and executing trades can usually be completed within a day or even in seconds.
But we cannot underestimate the complexity of the trading mechanism it poses on the beginners. They need to learn about brokers, CDP, custodian accounts, commission costs, bid-ask spreads, bid-ask volumes, order types, trading hours, ex- and cum-dividends and many more. This can be intimidating to anyone who tries to make sense of it for the first time.
A DIY stock investor is an administrator
A fund is usually supported by middle and back office staff. One important aspect is the calculation of the fund performance. For bigger funds, they may even have full time fund accountants to calculate the Net Asset Value for each trading day.
A DIY stock investor must keep a good record of his trades. He must also know how to calculate his investment returns – time weighted or money weighted returns? This is a task which most investors overlooked. Performance to them usually means looking at the profit and loss of each individual stock. But they are clueless about how the entire portfolio is doing. The math can be abstract but nonetheless important to understand. The easiest way is to use the XIRR function in an Excel worksheet to calculate returns. But one must also diligently record the entries to piece up the performance and maintain it through the years.
This is grunt work but necessary if you want to improve as a DIY stock investor. What gets measured, gets improved.
Have you done these? Do you still want to be a DIY stock investor?
As you can see, it is not easy being a DIY stock investor. You are your own fund manager, analyst, trader and administrator. Each role has a learning curve and it takes time and effort to perform the tasks. Moreover it is a continuous effort which most people do not have the luxury of time or discipline to maintain over a long period of time.
Hence, you should consider to invest in managed funds (active or passive) if you feel discouraged after reading this.
On the other hand, if you are still undeterred by what I have shared, it shows that you have an interest to do stock picking. This passion may provide the fuel and the drive for you to perform the roles of a DIY stock investor. All the best!