Watch CBSN Live

Should Average Investors Do It Themselves? An Alternative Viewpoint

Larry Swedroe recently wrote a MoneyWatch column entitled Should Investors Do It Themselves? In it, Larry referenced a piece written by William Bernstein in the Efficient Frontier entitled The Probability of Success, which presents four arguments against investors managing their own portfolios. Though interesting and persuasive, I must respectfully disagree with three of the four.

Before I start, let me offer a little candor. William Bernstein and Larry Swedroe are not only two of the smartest guys I know, but are also among the few white hats in the investing world. Both are prolific financial writers, and I ought to know since I buy and read everything they put out. In fact, Dr. Bernstein's upcoming book, The Investor's Manifesto, is one I ordered two months ago and predict will be sensational. So for the record, I am 99% in agreement with Bernstein and Swedroe. However, it's the pesky little 1% that fuels this column. Or maybe it's that tendency I have that seems to me to be devil's advocacy, and seems to my wife to be argumentativeness.

As I go through each of the four points, I'll contrast the argument with the success of my son's "second grader" portfolio which consists of three index funds - a total US stock, a total international, and a total bond. All are low cost and very broad index funds and his success is described in my book "How a Second Grader Beats Wall Street."

Here are the four arguments:

An interest in investing.It's no different from cooking, gardening, or parenting. If you don't enjoy it, you'll do a lousy job.
Buying the entire stock and investment grade bond market takes virtually no interest. Truth be told, I'm fascinated by the stock market and have a destructive habit of looking at the market ten times a day, which my son Kevin finds mind-boggling. Watching Mad Money may show interest, but is also likely to lead to lower returns.
The horsepower to do the math. As Scott Burns explained to me years ago, fractions are a stretch for 90% of the population. The Discounted Dividend Model, or at least the Gordon Equation? Geometric versus arithmetic return? Standard deviation? Correlation, for God's sake? Fuggedaboudit!
Well, my son understands fractions if nothing else. I'm a math geek, so correlations and standard deviations really blow my hair back.Yet the conclusion of all of this is to own the entire market and rebalance. My son is in sixth grade today and though he couldn't calculate a standard deviation or correlation if his life depended upon it. I'm happy to say he is still a better investor than I am.
The knowledge base-Fama, French, Malkiel, Thaler, Bogle, Shiller-all seven decades of evidence-based finance back to Cowles. Plus, the "database" itself-a working knowledge of financial history, from the South Sea Bubble to Yahoo!
I ran these by Kevin, and admittedly only two of them registered. He thought French was someone from France, so I guess that doesn't count, but did actually know who Jack Bogle was since he got a nice note from him. Even without this knowledge base, anyone can understand that owning the entire market with the lowest costs just makes sense.
The emotional discipline to execute faithfully, come hell, high water, or Bob Prechter. Mr. Bogle makes it sound almost easy: "Stay the course." Alas, it is not.
Here is the one I will agree with but argue it doesn't mean you should necessarily turn it over to an adviser. Mr. Bogle makes it sound simple as opposed to easy, because simple investing isn't easy. The wisdom of buying what we want when it's on sale, as the stock market was last March, seemed to elude most investors. Instead, our emotions caused us to hold what remained of our nest eggs in a death grip that would only be released when it was pried from our cold, dead fingers.

I agree that most individuals don't have this discipline but, unfortunately, neither do most advisers. A forthcoming study in the The Review of Financial Studies entitled "Assessing the Costs and Benefits of Brokers in the Mutual Fund Industry" shows that financial advisers and individuals both chase performance equally. My own study demonstrates that people pay a market timing penalty of about 1.5% annually by chasing whatever sector is hot. Other studies show this penalty is much higher.

My bottom line
So what's my conclusion as to whether investors should go it alone? Stay tuned for tomorrow's piece on "My Take on Investors going it alone."