How to Become a Do-It-Yourself Investor
It's not as hard as it seems.
At a party a few weeks ago, a friend turned to me and said, "I'd love to invest on my own, but I don't even know how to begin." You can't really blame her: She faces myriad investing choices, layers of fees, and the possibility of losing her shirt when things go wrong. That's why so many investors flock to financial advisors, attracted to the peace of mind that their guidance can offer. To be sure, many advisors offer valuable services, but others are less helpful. In fact, many academic studies have shown that investors working with advisors have fared worse than those who go it alone. That's partly because unwitting investors can end up with second-best portfolios, because brokers are sometimes paid to hawk certain funds over others. Higher fees also hurt. Advisors generally add sales charges or annual fees on top of those charged by mutual funds. So, all things considered, it often makes sense to grapple with your portfolio on your own. Not only is it generally cheaper, it's not much more difficult, and you don't have to worry whether your advisor is looking out for your best interests. In this article, I discuss three ways that investors can get started without the middleman or the associated fees.
The Bunny Slope
For those in search of simplicity, target-date retirement funds are about as low maintenance as it gets. Available at most of the larger fund shops, including Vanguard, T. Rowe Price, AllianceBernstein, and Fidelity, these all-in-one funds own a mix of stock and bond funds and slowly shift more heavily toward bonds as they approach their target dates. So, if an investor aims to retire around 2050, he or she would simply select a fund with that target date and the fund takes over from there. Of course, these funds aren't restricted to just retirement purposes. Investors with any long-term goals could easily use a target-date fund to meet their needs.
It bears mentioning that not all target-date funds are created equally. Some are stuffed full of mediocre underlying funds or charge egregious expense ratios. Even those that pass muster aren't right for everyone. Some, such as Vanguard's stellar lineup, take a more conservative tack, and others, such as those from T. Rowe Price, have more assertive portfolios. For a complete look at the ins and outs of these plans, take a look at this article by my colleague Chris Davis.
There is another breed of fund worth considering. Many fund of funds are a lot like target-date funds in that they offer one-stop exposure to stocks and bonds, but their stock/bond mix remains fixed. This gives investors the freedom to change their asset allocation over time while still getting a diversified portfolio in one fell swoop. Let's say you're a young investor who wants an all-stock portfolio. You could choose something like T. Rowe Price Spectrum Growth (PRSGX), which invests across a broad lineup of domestic and international T. Rowe Price mutual funds. You'll have 100% exposure to stocks for as long as you want. If you want to become more conservative, you switch to a similar fund that adds bonds to the mix, such as T. Rowe Price Personal Strategy Balanced (TRPBX) or the excellent Vanguard STAR (VGSTX).
Target-date funds or fund of funds are great for investors who want to take a hands-off approach, but what about those who want total control? Fund supermarkets allow investors to keep their investments all in one place without sticking to just one fund shop. Among the most widely known supermarkets are E*Trade, Charles Schwab, Vanguard, Fidelity, and T. Rowe Price. At supermarkets, investors can build their portfolios from scratch, choosing from among fixed-income funds, domestic and international equity funds, and nearly every other option (including individual stocks and bonds).
While fund supermarkets give investors lots of options, all the choices can be bewildering. We suggest starting with a more conservative option, such as T. Rowe Price Equity Income (PAFDX). Mild-mannered funds like this are less likely to tempt you to sell at the wrong time, after a major bout of volatility. Another word to the wise: Pay close attention to fees. Fund supermarkets may levy brokerage charges every time you buy fund shares, racking up big transaction costs in the process. And funds available for purchase with no transaction fee often feature higher expense ratios (there's a good reason why you're not paying any transaction fee). Costs are one of the few things in investing that you can control, and remember that they come right out of your returns. So try to keep them to a minimum.
For a more thorough discussion of the issues to consider when buying funds at a supermarket, check out Christine Benz's list of things to keep in mind when buying funds at a supermarket and Karen Dolan's appraisal of various supermarkets.
After setting up the portfolio, there are just a few more things to consider. Investors should evaluate their tax situation and decide on a taxable or tax-deferred account. We discuss taxes and their impact on your portfolio here. Also, be sure to do periodic checkups. For those invested in a number of funds, checking in at least once a year should help make sure that the portfolio allocations are still correct, given evolving financial needs and time horizons. It should also help keep investors abreast of any changes at the funds they own. Funds aren't static investments. Managers can change, expenses can rise or fall, and strategies can change. Regular reviews should allow investors to make any necessary modifications, should the fundamentals deteriorate.
Marta Norton does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.