Investing by yourself– Do you know what you are doing?

I always shudder when someone tells me that they are managing a few million dollars of their own money through a discount brokerage firm. Do they actually know what they are doing?

I randomly asked a few friends who have been investing on their own for years. How do you select the stocks that you buy and how do you know when to sell, I asked? The answers are not what you should expect.

No one professes to have a crystal ball. At the same time, few actually look at the financial information that companies file with the SEC. Professional investors all over the world use fundamental securities analysis to compare balance sheets between companies they are considering for investment. Self-directed investors rarely tell me that they even know how. It seems that a great many of the investment decisions that they make are emotional rather than rational.

More than one has told me that they get tips from a pundit on TV or a newsletter that they have come to respect. And how did they earn your respect, I ask? By being right more than wrong is the best answer I got but even that tells you nothing about the methodology behind the recommendations.

Remarkably, many people do not seem to trust the large wire houses and investment banks and the registered representatives that work for them. People use words like “crooked” and “conflicted” when they refer to these firms. If a research analyst at one of these firms writes a report regardless of quality, many people seem to dismiss them as dishonest.

More than one person told me that they invest in companies that have great new products coming out. You know that we believe that the fact of the new product is factored into the price of the stock as soon as the product is announced, I asked? For the most part, people, even those investing seven-figure accounts of their own money do not know what I am talking about.

The problem becomes more obvious when you ask: how do you know when to sell? Do you set targets or use stop losses? You really don’t think that I got a single affirmative answer, do you?

When I visit my financial adviser during the trading day, he may have half a dozen screens on; a financial news station with a live ticker; specialized screens following specific stocks that his clients own or which he is considering buying. He follows the market and “his” stocks, all day, every day. Is that how you manage your portfolio?

Even if you are well schooled in balance sheet analysis what do you know of the global markets, global economics and global politics. Forty years ago, Proctor and Gamble was a primarily domestic company. Today it operates in so many markets and has suppliers in so many others that its earnings can be affected by things that you cannot imagine, let alone identify and analyze.

As I got older, I came to realize that part of being wise is knowing what it is that you don’t know. It is true in life and especially in investing.

Ending fixed commission rates was a step toward market efficiency. The idea of discount brokerage firms where customers could purchase mutual funds and set up simple portfolios by themselves was likewise efficient.

The step from there to “do it yourself” with all of your money is a big one. Most self-directed investors do not have what it takes to avoid stumbling.

Emotional, irrational and uneducated investors contribute to market inefficiency. Every time that the market crashes more and more self directed investors come away with significant losses. Investing profitably is a lot harder than it looks. It takes time, attention, data and the knowledge of how to use that data.

If you do not think that you could pass one of the mid-term exams that I used to give to my students, hire an investment adviser.

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