Hidden Challenges for DIY Investors and Ways to Overcome Them
Investing on your own can be rewarding, but it’s not without its difficulties. Adam Bornn, from Parallel Wealth, highlights eight challenges DIY investors often face in his YouTube video, “8 Hidden Challenges Every Investor Should Know.”
While Adam provides valuable insights, his perspective seems to assume that all DIY investors approach the market similarly—primarily through individual security selection. Let’s explore these challenges, assess their implications, and see how you can sidestep common mistakes with practical solutions.
The Weight of These Challenges
Time Commitment
Adam suggests managing financial data and conducting regular reviews requires significant time. That is a fair statement if your plan involves picking individual stocks and bonds. Many potential DIY investors may feel overwhelmed by even contemplating the time burden, leading to procrastination or avoidance. Frankly, if DIY investors don’t feel overwhelmed, then they are almost certainly doing something wrong. Do you seriously think that you can outperform one of the Securities divisions of Canada’s big banks that send out teams of analysts to remote mining installations to make a buy/sell/hold recommendation to their clients?
Emotional Decisions
Although investing is portrayed as primarily mathematical, money is profoundly emotional. Consider the number of marriages that have broken down due to financial problems. Emotional reactions can lead to poor decisions, especially if you don’t have someone who can act as a voice of reason to temper your responses. Among the mistakes DIYers make is withdrawing their investments during a market downturn, leading investors to sell at a loss. While it may feel like financial self-preservation at the moment, repeated capital losses in the face of short-term downturns can have a long-term negative effect.
Another example of emotional decision-making, although not precisely about investing, involves starting CPP benefits as early as possible, giving up on the probability of significantly increased payouts by deferring past age 65. While there are legitimate reasons to take CPP before age 65, the fear that “CPP won’t be there for you” is not one of them.
Missed Opportunities
Familiarity bias often restricts investors to sectors or assets they know, like the industry in which they work or buying only Canadian stocks (this is known as home bias). While this may feel safe, it limits exposure to the broader market, leaving investors vulnerable to sector- or country-specific downturns. This prevents investors from investing in a suitably diversified portfolio, which is one of the keys to reducing risk and maximizing returns over time.
Familiarity bias and home bias originate from a fear of stepping out of our comfort zones. Familiarity equals emotional security even though it will often lead to poorer returns.
Tax Inefficiencies
Tax inefficiencies can be a hidden problem for many investors, especially those new to DIY investing. Without careful planning, Adam says, investors may put the wrong investments in the wrong accounts. For example, holding Canadian stocks that pay dividends in a TFSA instead of a non-registered account can mean losing the benefit of the dividend tax credit. Similarly, putting high-growth investments in a non-registered account can lead to higher taxes on gains, reducing returns over time. Adam points out that DIY investors need to understand these details, especially when switching from a traditional advisor, who might have handled these choices for them. However, learning the tax rules and keeping up with regular portfolio checks can feel like a burdensome challenge for someone new to this.
For many DIY investors, the worry about tax inefficiencies adds extra stress. The fear of making a costly mistake—like missing out on tax savings or facing penalties—can lead to doubt and second-guessing. This is especially true during tax season or when rebalancing the allocation of your investments. Stress like this can stop investors from acting, leaving them in less-than-ideal situations. Some might even overcomplicate their tax strategies, causing frustration or burnout and making it harder to stay confident in their DIY approach.
Hidden Fees
Foreign exchange (FX) fees can quietly reduce an investor’s profits, especially when buying U.S. stocks from a Canadian account. Adam points out that some platforms, like Wealthsimple, charge a 1.5% fee for currency exchange both when buying and selling U.S. investments. This adds up to a 3% cost, which can make a big difference in returns. From my experience as an investment representative, I remember DIY investors often ignoring the effect of exchange rates. For example, even when using a U.S. dollar account, one investor moved money from her Canadian (CAD) account to her U.S. (USD) account, and bought and sold a U.S. stock in two days for a profit in USD. But after converting her money back to CAD, her gain turned into a loss. Not understanding how exchange rates work when trading in USD can lead to unexpected losses.
No Accountability
Adam points out that one big challenge for DIY investors is the lack of someone to hold them accountable. Without a second opinion, it’s easy to make quick or poorly thought-out decisions, like chasing trends or reacting emotionally to market changes. Even smart investors can let their emotions take over or become too sure of their decisions, especially when markets go up and down quickly. Adam believes that having an outside voice—like an advisor or an investment club—can help keep decisions steady and focussed on long-term goals and provide emotional stability.
Overconfidence Bias
When markets are doing well, investors often see higher returns than expected, which can lead to overconfidence. Adam observes that this success may push them to take bigger risks, such as putting money into investments that are too risky or using margin (borrowing against the value of their investment portfolio to invest more in stocks) more than they should. For DIY investors, this can be especially dangerous if they do not fully understand the risks involved. Good results during strong markets can make investing seem easy, leading some to believe their success is due to skill rather than good market conditions. This false sense of security can leave their portfolios unprepared for the next market downturn.
Opportunity Cost
Opportunity cost is an important idea in investing but one that many people misunderstand. It refers to what you give up when you choose one option over another. For DIY investors, this might mean putting money into investments that offer lower returns when better opportunities are available. Adam highlights that some DIY investors hesitate to act because they focus too much on what they might lose instead of the gains they could make. This can lead to poor use of their money or a lack of trust in their ability to stick with DIY investing.
The emotional effects of missing out on opportunities can weigh heavily on investors. Fear of making the wrong choice can lead to “analysis paralysis,” where they take no action at all. For others, looking back at missed chances may cause regret, especially if other investments performed better. These feelings can create doubt about the DIY approach, making it harder to move forward with confidence and stick to a long-term plan.
Smarter, Simpler Strategies for DIY Success
Adam Bornn’s concerns are legitimate, I think, but, in my opinion, they can be adequately resolved with some fairly simple strategies.
Minimizing Time Commitment
DIY investors can use asset-allocation ETFs or global balanced index funds, whether in separate components or in a single fund that requires minimal upkeep. This will save time without sacrificing diversification.
I should note that, if DIYers intend to invest in individual stocks or bonds, then this will unavoidably require additional time. In addition, regardless of that extra effort, it will almost certainly result in greater uncertainty of returns and a higher risk of underperforming the broad market.
Reducing Emotional Decisions
Despite the justifiable rise in using ETFs in Canada, mutual funds do have a unique quality that the DIY investor can take advantage of to reduce the impact of emotions in investment decisions. The first step is to set up automated recurring transfers from your bank account to your investment accounts. This ability includes ETFs, too, as it does not involve purchases.
The second step, and to my knowledge, exclusively available for mutual funds, is to automate contributions so that a set amount can be invested every two weeks, for example, to coincide with one’s paycheque. The DIY investor can always cancel those recurring transfers and investments, but it requires an active choice, unlike the situation where nothing is automated, and every transaction requires a choice to be made. The choice to use mutual funds, though, generally involves higher fees, so there is a trade-off in most circumstances.
If you are a potential DIY investor and you want both ETFs and automation, then your best alternative is to go with a robo-advisor. However, you will have less control over the precise assets you want to select.
Avoiding Missed Opportunities
As I already indicated, the decision to invest in individual securities will necessarily involve leaving out some investments while emphasizing others. This is a recipe for underperformance as individuals there is no guarantee or even likelihood that your picks will turn out to be the “winners” in the stock market. For that reason, the only way to avoid those missed opportunities is to embrace global diversification through a diversified ETF or mutual fund portfolio.
Maximizing Tax Efficiency
Adam was mainly concerned about “asset location” strategies that match asset types with the appropriate account type. For example, put Canadian dividend-paying stocks (or Canadian dividend-focussed funds) in non-registered accounts because of the tax-advantaged gross-up and tax credit arrangement, or put fixed-income assets inside RRSPs because withdrawals from an RRSP come out at the same tax rate as regular income. I could go on. In fact, I have in this blog post.
The bottom line is that I discourage this sort of asset location strategizing. First, maintaining this strategy gets more complex as your assets grow. Second, it can be counterproductive. Exposing equity investments to taxation while keeping the RRSP as the sole domain for fixed-income means that you lose decades of tax-deferred potential growth from equities. Instead, I encourage DIYers to focus on balanced, tax-efficient portfolios across all account types.
I will conclude my comments on asset location by mentioning one strategy that has to do with TFSAs. There have been a few examples over the years where certain investors were able to select a handful of the right stocks to put in their TFSAs and in the space of a year or two, find themselves with million-dollar accounts that were entirely tax-free. Seeing that kind of performance encourages other DIYers to take the same approach. However, that kind of outcome is rare. That’s why it gets in the news! Imagine all the others who have invested in more speculative assets and found that their investments have dropped to zero. It’s a pure loss. That’s why I encourage those who insist on scratching their speculative itch to do so in a non-registered account where you can at least claim a capital loss and use it to reduce taxable capital gains from up to three years earlier, the current tax year, or indefinitely into the future.
Beating Hidden Fees
In Adam’s scenario, this had mostly to do with FX fees when trading in US securities. On that point, I would like to suggest three options to reduce this cost:
- Do not buy U.S.-domiciled securities. Unless you have a particular reason to buy securities in USD, you can easily buy Canadian-domiciled ETFs that invest in U.S. securities. In addition to the avoidance of complications associated with foreign exchange, including the tax-related calculations of the Adjusted Cost Base (ACB), and capital gains or losses, this avoids U.S. Estate Tax filing issues if your U.S.-domiciled assets exceed US$60,000.
- If you have a reason to invest in U.S.-domiciled securities, or even Canadian-domiciled securities that trade in USD, then use a USD brokerage account and keep your USD inside that account for the long term. Don’t flip back and forth between the Canadian side and the U.S. side of your investment account more frequently than necessary. The frictional costs associated with those exchanges can seriously erode your returns.
- When you need to transfer CAD into USD or vice versa, use Norbert’s Gambit (note that settlement is now only one business day). This is not without some frictional costs, but it is usually at a rate that is much lower than the FX rate that your investment firm will charge.
Creating Accountability
In all honesty, I don’t have a lot to say about this one. There are local investment clubs that one can join, but my impression has been that these groups usually have a rather strong orientation toward active trading of individual securities. There are also lots of Facebook pages that one can join for ideas on investing, although the temptation to always find an edge that will allow DIYers to beat the market seems to be found there as well. The most frequent example I see is the tendency to use ETFs (generally good) but buy only one that is focussed on a currently high-flying sector (not so good). In other words, join investment communities with caution.
Managing Overconfidence Bias
One way to address this issue is to create and stick to an Investment Policy Statement (IPS). An IPS is intended to guide your decisions in a systematic, well-considered way, without succumbing to the “next big thing” to which you are attracted. Included in this IPS should be a requirement to rebalance regularly, so that you get your investment risk back in line with the long-term plan that you articulated in your IPS.
Understanding Opportunity Cost
Looking back to the beginning of 2024, you might feel bad that you chose to invest in a globally diversified portfolio rather than putting it all in an ETF that tracked the U.S. S&P 500 index. The performance difference is about 10%, depending on the ETFs you are comparing. However, the point is not to attempt to “knock out the lights” with every investment decision. Rather, the goal is to invest so that your money achieves a desired purpose (e.g., funding your retirement, setting aside enough money for a down payment on your first home, providing money for your children’s post-secondary education) and does so within your risk tolerance. Once again, having an IPS in place can help you achieve these purposes without “flitting” from one idea to another in the hopes of outperforming the market and fretting over lost opportunities.
Empowering Investors with Knowledge and Tools
The solutions above are designed to simplify and enhance your DIY investment journey. By addressing each of these challenges head-on, you can create an investment portfolio that aligns with your values, goals, and risk tolerance without all the stress.
Turning Challenges into Confidence
Investing doesn’t have to be overwhelming or isolating. With tools like automated investments, low-cost ETFs, index funds, and a well-crafted IPS, you can confidently navigate the markets even as a DIYer.
This is the 273rd blog post for Russ Writes, first published on 2024-12-16
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Disclaimer: This blog post is intended for general information and discussion purposes only. It should not be relied upon for investment, insurance, tax, or legal decisions.
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