With the costs and restrictions of a traditional professional portfolio manager, it can be tempting to try to avoid fees and be in greater control of your money by managing a portfolio yourself. In theory, you could imitate a target portfolio when you first set up the portfolio, but given the expertise and time required, it’s not as straightforward to maintain the portfolio as it may seem.
Unless you are trading in the markets as a hobby, and not to save to achieve a life goal, such as retirement, it's important to evaluate and understand what's involved in portfolio management when you're making the decision of whether or not to go with a portfolio manager. Here, we cover what goes into effective portfolio management, from asset diversification, risk management, time, to costs, so that you can make the decision that is best for you.
Spoiler alert: Investing on your own may not earn you, nor save you, what you think it does.
Not all portfolios are created and managed similarly, as a portfolio's composition and management strategy greatly depend on what amount of money you are trying to earn in a given period of time with a certain risk level. A long-term retirement portfolio, for example, will have different investment parameters and risk levels compared to a short-term wedding savings fund. It takes experience and knowledge to know how to build these different types of portfolios, which involves effective asset allocation and diversification.
Asset allocation is the strategy of dividing an investment portfolio into different asset classes and subclasses to achieve the highest expected returns for the given level of risk the investor is willing to assume. Several long-term studies have concluded that asset allocation is responsible for between 80% and 96% of a portfolio’s total return. Determining the asset allocation of a given portfolio requires one to consider many market, economic, and external variables, and how they correlate to each other in both the short term and long term.
Diversification minimises concentration risk by spreading investments out across a large number of securities across asset classes or market segment that exhibits similar risk and return trade-off profiles. To illustrate, let’s consider the differences between investing all of one’s funds into Apple shares versus a portfolio of 30 technology stocks: In the first case, an investor is fully exposed to any events relating to Apple (stock splits, earnings surprises, new products announcements, and so on). In the latter case, the investor is significantly less exposed to company-specific risks. The level of diversification, as illustrated in the Apple example, minimises volatility, and therefore unnecessary risk.
Setting up the right asset allocation and applying optimal diversification is certainly key, but managing a portfolio also requires managing risk throughout market and economic changes that affect the asset allocation.
In the inevitable case that market and economic activities compromise your original asset allocation, it’s critical to rebalance your portfolio back to its target asset allocation. Rebalancing is a function of quantifying and monitoring the portfolio’s exposure to risk, and making sure that you maintain the intended balance of risk and returns in a given portfolio by trading securities when appropriate.
Knowing what to sell and what to buy to return the asset allocation back to its target is not always straightforward. For example, if you had 14% of your portfolio allocated to small cap equities, do you know at what percent change you should trade to maximise your returns while maintaining your target level of risk? If, due to changing market conditions, small cap equities grew to 20% of your portfolio, would you know which assets to buy and sell to get back to your target allocation? Knowing when to sell may be even more important than what to sell. Seasoned, technology-savvy investors know that rebalancing whenever there is a slight change of a few percentage points in the portfolio’s allocation isn’t optimal, and have automated models that help make the right decision at the right time.
In the case of major economic cycle shifts, a portfolio manager will actually make significant changes to the portfolio’s target allocation, known as re-optimising a portfolio, to address the new conditions that impact a portfolio’s exposure to risk and return. It takes incredible expertise, extensive number crunching, and advanced technology to first recognise the economic shift, and then to make the appropriate changes at the right time.
There are costs associated with investing that are worth reducing wherever possible, as costs directly impact returns. Despite charging management fees, portfolio managers are often able to achieve cost efficiencies that individual investors are not always able to achieve.
As an individual investor, you’ll likely face minimum trade amounts that a manager does not necessarily have. This can be limiting when trying to deploy a certain investment strategy. Portfolio managers also have the ability to utilise tools such as fractional shares and rebalancing, as discussed. Fractional shares and rebalancing performance efficiencies, as well as incredible precision, through technology that is not readily available to the general public.
Brokers for individual investors often charge per trade. Let's say your broker charges a minimum of $20 USD per trade, and you want to invest in a diversified set of 10 ETFs each month. This means that you will be spending a minimum of $200USD/month just on trades. As a percentage of your investments, this amount will be 20% of your investments if you invest $1,000 USD/month, and less than 1% only if you invest more than $20,000 USD/month. By investing on your own, you are liable to much higher transaction fees than if you were to compare it to the percentage fees charged by portfolio managers, that can range from 0.5% up to 2.0 - 3.0% per annum. Institutions can negotiate better trading rates with their brokerage partners, therefore minimising costs.
Because they are managing numerous portfolios, portfolio managers have access to buy and sell in bulk, and do not face 'per trade' costs with their brokers.
Brokers will also charge a percentage of your assets in the case that you wish to invest in a security, other than futures contracts, that are in a different currency denomination than your cash. For example, if you have HKDthat you want to use to invest in an ETF that is in USD, you will be charged a foreign exchange rate in addition to the transaction fee. Brokers have a minimum trade size per month, and if you trade less than this amount in a month, your foreign exchange conversion fees will likely be very high, hurting your returns. There is no standard, but the costs can range from 0.33% to 1.0% for one trade, and the fees apply to both buying and selling.
It takes a lot of time and expertise to analyse the markets and the economy. Because you likely aren’t able to commit a few hours a day, due to a full-time job, to monitor the dynamics that directly impact your portfolio, the chances of missing trends that would require re-optimising your portfolio are amplified.
Managing your investments also requires great discipline. Portfolio managers can work with you to build investment strategies based on these monthly deposits to make sure that you make regular monthly deposits to keep you on track even when life's distractions get in the way.
Entry and management fees, as well as minimum balance and deposit restrictions, can impact your returns, or at the very least, not adhere to your preferences. Such factors can be a deterrent from using an investment product under a portfolio manager. But, when you’re deciding how to invest your money, understand what you are gaining with a manager or advisor, and know what you are personally capable of when it comes to managing your own investments. You may have more options than you think to make the most out of your savings.
We created StashAway to remove these restrictions, and to lower management fees, so that you have flexibility with your investments, and can reach your investment targets more easily. That means you can set your goals and deposits easily, and let us do the rest.