What is Self-directed investing?
Self-directed investing or do-it-yourself (DIY) investing, is an investing method that puts you in the driver’s seat to build and manage your investment portfolio, without the support of an investment professional or automated service like a robo-advisor. Self-directed investors commonly use discount brokerages and online trading platforms to place trades.
Self-directed investing vs. day trading: knowing the difference
A common misconception is that self-directed investing and day trading are the same. Day trading is a type of self-directed investing that focuses on the high-risk short-term buying and selling of investments to capitalize on their fluctuations in pricing. Day-trading is complex and is not recommended for new self-directed investors. Fortunately, there are other strategies self-directed investors can use, including passive investing (see below).
Advantages and disadvantages of investing on your own
Self-directed investing is not for everyone and those who jump in without adequate investment knowledge can make costly decisions. Consider the following before choosing self-directed investing:
Advantages
Defining your investing journey.
Taking a self-directed approach allows you to adopt the investment strategy you feel will help you to best reach your financial goals. A robo-advisor and financial advisor will provide you with a recommended investment portfolio. As a self-directed investor, you can build your entire portfolio and choose what you believe is the optimal time to buy and sell your investments.
Potentially lower fees.
Investing on your own can be potentially save you money as you are not paying for the fees associated with an advisor’s services or those for using a robo-advisor platform. In addition, you may benefit from potentially lower trading fees and commissions from discount brokerages.
Varying levels of complexity.
Self-directed investing allows you to develop investment portfolios as simple as you want with securities like passive index funds or as complex as you want with higher risk securities like stocks, options and alternative investments like crypto. Investors can increase or decrease the complexity of their portfolio with minimal interaction from others to do so.
Disadvantages
Expensive trading mistakes
If you lack an understanding of investing fundamentals and how to sufficiently research an investment, you can potentially make costly investing mistakes and even fall victim to fraud. Likewise, if you don’t properly understand how to use online discount brokerages and trading platforms, you can make unsuitable trades.
Ease and convenience can play into your emotions and lead to impulse decisions
The convenience of today’s online brokerage platforms has allows investors to easily place trades and monitor their accounts like never before. However, this speed and convenience though can be a double-edged sword for impulsive or emotional investors who might make costly impromptu decisions based on recent news, friend or family recommendations and online speculation rather than on research, rational analysis and a long-term plan.
Lack of a financial plan can lead to poor performance
Regardless of how you invest, without the foundation of a strong financial plan with defined goals and an understanding of your risk tolerance, it may be difficult to choose suitable investments that will best help you reach your goals. Worst yet, investors without a financial plan are more susceptible to get-rich-quick investment scams, investment anxiety, market distraction, and the fear of missing out (FOMO).
Is self-directed investing suitable for you?
Taking the time to understand your needs and knowledge as an investor is an important first step when deciding how you would like to invest. When assessing if self-directed investing is the right approach for you, consider the following first:
How well you know yourself
We are all unique in terms of our personal finances and goals. Ask yourself what you aim to achieve with investing and whether you have a clear understanding of your risk tolerance (your ability and willingness to take risks with your money).
Your investment knowledge
Making your own investment decisions requires you to have a thorough understanding of the different investment types available and how to properly read and research investment information such as a stock ticker or investment fund fact sheets. You will also need to understand how to trade investments and how to use trading platforms. Familiarize yourself with these important aspects before you start and continue to strengthen your investment knowledge over time.
Your emotions and discipline
Successful investing requires you to ignore short-term market volatility, downturns, and market speculation. Instead, you should use a disciplined long-term approach towards your goals and a portfolio of suitable risk –aligned investments. Consider how a market downturn that could negatively impact your investments by 15 per cent or even 50 per cent would impact your emotions and investing decisions. If you feel like you would make sudden or emotional investment decisions you may want to opt for another investing method.
Your interest and dedication and interest to investing on your own
Remaining interested and dedicated to managing your portfolio is a key to being a successful self-directed investor. Realistically consider the amount of time and interest you have in learning about investing and monitoring your investments.
Active vs. passive investing
Self-directed investors generally use two main strategies for investing.
Active investing: you actively participate in trading investments with the goal to outperform market benchmark returns. Active investing can produce higher returns than passive investing in the short term (under five years), but exposes you to much higher levels of risk.
Passive investing: investing in index funds or broadly diversified investment funds to generate returns that replicate the benchmark returns of the market or the sector. Passive funds generally have little to no human management.* Passive investing relies on the fundamental principle that markets have increased in value over time and have historically provided higher returns compared to active investing over the medium to long-term time horizon (e.g. five years or more).
*Some passively managed funds do have some degree of active management in the rebalancing of investments within the fund. Generally the fees for passive funds are lower than those for actively managed funds, in which investment professionals are researching and selecting the investments they believe will yield the highest return on a continuing basis.
Examples of active investing
- individual stocks
- active investment funds
- crypto assets
Examples of passive investing
- index funds
- passively managed investment funds
- all-asset allocated funds
When considering a strategy for self-directed investing, you do not have to choose between active or passive investing. Based on your risk tolerance, preferences and financial goals, you may opt for a mix of both types.
Tips before you start self-directed investing
Regardless of the strategy you select, to pick suitable investments for your portfolio, remember these critical tips to avoid fraud:
- Always ensure that the online brokerage or financial institution you plan to use for your self-directed investing is registered with the securities regulator in the province or territory you reside.
- Understand your risk tolerance before you start investing to avoid exposing yourself to risk levels you may not be comfortable with. Take our Check your risk tolerance quiz.
- Be wary of online investment advice. Some advice may be from unqualified individuals or worse yet, fraudsters trying to entice you to invest in a scam or through a fake trading platform.
Other options for investing
If self-directed investing doesn’t seem to be the right path for you, that’s ok. There are other options, such as using a registered financial advisor or robo-advisor for your investment needs.
