You Don’t Need A Broker: 9 Keys to Investing Successfully On Your Own

by Millionaire Mommy Next Door on June 19, 2010

in How To Guide,Investing

I’m sure there are investment brokers worth their high commissions and fees, but I haven’t experienced one. I burned through five brokers before realizing that no one cares as much about my money and my future as I do. Brokers are salespeople. Naturally, they care more about their bottom line than mine.

Most people I coach don’t realize that they’ve been paying a 5-6% sales commission every time they buy new mutual fund shares because the commission is built into the price, making it difficult for the investor to “see” it. And paying a sales commission has nothing to do with the performance of a fund; you aren’t buying a better fund simply by virtue of paying more for it.

Each year, I’d compare my broker-managed portfolio’s performance with the stock market indexes (Wilshire 5000, S&P 500, Dow Jones Industrial Average, NASDAQ, MSCI EAFE, etc.). I found that despite paying a decent sum to brokers for their expertise, my portfolio usually under-performed the standard index benchmarks. In 1999, I decide that it was worth my time and energy to learn how to manage my own investment portfolio. My efforts have paid off very handsomely. Here’s a down-n-dirty summary of what I’ve learned:

1. Start Today

Start as early as possible to take advantage of the astounding power of compounding growth. By reinvesting the gains you receive from the money you invest, you can double your money in less than eight years assuming a 10% average annual return. Take a look at the following example, then try this calculator to see how much postponing your savings plan could cost you.

Start Now:
Save $10,000 per year for 30 years
@ 10% annual rate of return
= $1,809,434 ending balance

Start Later
Postpone saving for 10 years, then save $10,000 per year for 20 years
@ 10% annual rate of return
= $630,025 ending balance

Cost of waiting = $1,179,409

2. Put Your Investment Contributions on Auto-Pilot

Instruct your bank to automatically transfer at least 10-20% of your gross income to your investment account each month. If you don’t think you can afford to do this then you can’t afford your lifestyle! Get creative, cut expenses elsewhere, and start paying yourself first.

3. Maximize Retirement Account Contributions

How taxes are applied to an investment can make a big difference in the long run. There are tax advantages to retirement accounts which is why (in most cases) you should maximize your contributions to these accounts first, then add to your taxable accounts. Additionally, some employers match your contributions — which equals free money. This calculator compares a normal taxable investment to two common tax advantaged situations: 1) an investment where taxes are deferred until withdrawals are made, and 2) an investment where taxes are paid on money that goes into the account but all withdrawals are tax free.

4. Be Mindful of Fees and Do It Yourself

Invest $10,000 each year and use a broker to place your order and you might pay $575 per year in sales commissions. Alternatively, learn to place investment orders yourself and your commission savings, compounding 10% annually, would be an extra $104,042 in your pocket in 30 years. Invest in a low-cost equity portfolio using no-load mutual funds, Exchange Traded Funds (ETFs) and index funds. Even a small difference in the fees you pay on your investments add up over time. Use this calculator to see how different fees can impact your investment returns.

5. Diversify and Build a Balanced Portfolio

Speculative investments are like eggs: when they fall, they make a mess. Don’t place your bet on a single stock or sector. Spread your risk into a variety of market caps and styles as well as domestic, foreign and emerging markets. Proper diversification helps your portfolio weather any ups and downs the market can take. Asset allocation accounts for 94% of the variation in portfolio returns, while market timing and stock picks account for only 6% (Gary Brinson, Randolph Hood and Gilbert Beebower). Review and rebalance your portfolio annually to maintain your desired allocation percentages. The Asset Allocator calculator is designed to help you create a balanced portfolio of investments. Your age, ability to tolerate risk, and several other factors are used to calculate a desirable mix of stocks, bonds and cash.

6. Don’t Invest Money You Can’t Afford To Lose

Rises and falls in the stock market are normal and frequent. Don’t invest your emergency fund into the stock market because you don’t know when you’ll need to use it. Money you may need within the next few years doesn’t belong in the stock market either. Investing for portfolio growth is your long-term goal.

7. Cover Your Ass

Protect your growing wealth with adequate insurance. The number one cause of bankruptcy is major medical expenses. In addition to medical insurance, consider coverage for disability, life (consider a term policy rather than whole life), auto, homeowner/renter, business, and personal liability. Buy policies with the highest deductible you could afford to cover from your emergency fund — and invest what you save from the reduced rates.

8. Understand Your Assets and Liabilities

Most people consider the home they live in as an asset but the truth is, it’s a liability. And if you are counting on future home appreciation, it’s speculation. Stop thinking of your home as a savings account. Don’t believe the sales-pressure hype that homeownership is your best investment: you’re spending money on a property that isn’t producing income. If you insist on owning real estate as a part of your investment portfolio, buy an investment property that produces a positive monthly cash flow.

If you’re finding it difficult to squeeze your budget for investment contributions, downsize to a smaller home. Invest any remaining home equity, plus your new-found monthly savings, into your long-term-growth portfolio.

9. Don’t Invest Until You Understand

Question every piece of advice you are given through the filter of “what’s in it for them?” Unfortunately, there is no shortage of people who are skilled at separating you from your hard-earned money. It pays to be suspicious. If you aren’t committed to learning how to self-manage your investments, consider hiring a FEE-ONLY financial adviser (rather than a commissioned-sales broker) to assist you.

What I’ve offered today is a summary. I’ve shared my opinions and experiences. But don’t just take my word; ask questions and read investing books and web sites. Learn about different investing strategies and styles, assess your own personal risk tolerance, make a plan, then stick to it. Use your head — not your emotions — to guide your decisions. Practice investing first, using virtual online applications (not real money), as you wean off of your high-commission broker.

oooOOooo

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{ 12 comments… read them below or add one }

Anonymous June 23, 2010 at 9:37 pm

10% return? Can you please list where someone can find or get a 10% return?

I just read a report on investing today, written by a famous successful investor and he said this-

8 percent annual returns are nice, but is it worth the occasional 40 percent decline?

He was referring to the stock market where 8-10+% returns are possible. The same point applies to your 10%. Is it worth it?

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Bankruptcy Ben June 25, 2010 at 1:09 am

it’s the shortest excellent PF book i’ve ever read. You covered everything I think. Your last point was particularly valid

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Millionaire Mommy Next Door June 25, 2010 at 10:29 am

@Anonymous, I used the standard historical “long-term compounded average annual return of 10%” for illustration purposes in this example. Obviously there are assets which have rewarded investors far more than this and others far less. I think your point is that today’s economic climate is very volatile (I agree) and that everyone must assess their personal tolerance for risk. Risk management is key — and a great topic for a future post!

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esther November 2, 2011 at 6:49 pm

Totally getting into this late, but you were making an illustration with a historical formula that is shot. People who have made millions speak in generalities, like: “there are asets which have rewarded investors far more than this” without specifying which investments they are and what the risk ratio is. Also, the constant mantra about educating yourself – I can’t crack the code. I don’t know where to look for information, or even what information should be analyzed to get information on markets, industries, stocks, financial institutions. It would be great for someone to actually break out in specific terms how they analyze the markets to make profits.

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MakingaMillionDollars June 29, 2010 at 3:46 am

I understand that risk is involved in everything we do and all decisions we make. I think the key is to minimize that risk through diversifying and dollar cost averaging into the market over a long period of time. This takes much of the variation and risk out.

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Chad June 29, 2010 at 6:59 am

Diversifying and dollar cost averaging are false risk reducing tools.

Standard silo diversification (specific static percentage for each asset class) did nothing for anyone in the recent downturn.

The actual benefit of dollar cost averaging is not the cost averaging, it is just that it forces most people to invest who wouldn’t.

In my mind these are passive investment strategies in an age that requires active investment strategies. This does not mean I don’t like a forced weekly/monthly contribution. Just that I don’t like the forced contribution because of cost averaging.

Also, concerning investment return it would be interesting to see how a “safe” 6% investment return strategy faired against a “risky” 10% strategy in the recent downturn. I bet there wasn’t much difference considering a “safe” stock like GE got absolutely destroyed.

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MakingaMillionDollars June 29, 2010 at 12:40 pm

I disagree on Chad statement on dollar cost averaging. Yes, it would have helped you in the recent downturn. Many people yanked all their money out of the market dropping prices on great companies to all time lows. If you continued to invest through regular injections of money into these great companies at these low prices you should have seen a huge increase as those stocks moved back up. We have had good increases since then. Sure we might have more drops, but regular investing in great stocks over the long haul will ensure you are buying those stocks on the cheap. I don’t believe trying to outguess the market in the new economy is the answer, you will lose every time.

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Chad July 6, 2010 at 9:09 am

Of course, someone disagreed with me, as what I said goes agianst the “investment gospel” we have been force fed. Of course, this advice was created by the same people who put us in this hole to begin with and profit from us following the “gospel.”

I didn’t lose and haven’t lost for a while on market timing big events. They usually aren’t to hard to predict, and when they are you just stay out of the way. Now, absolute bottoms or tops are hard to predict, but that’s not necessary.

Don’t get me wrong. At some point just blindly throwing money at winning and losing stocks on a monthly basis will work again, but not until this volatility is gone.

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Dolly Serrano December 23, 2010 at 7:25 pm

I disagree on Chad statement on dollar cost averaging. Yes, it would have helped you in the recent downturn. Many people yanked all their money out of the market dropping prices on great companies to all time lows. If you continued to invest through regular injections of money into these great companies at these low prices you should have seen a huge increase as those stocks moved back up. We have had good increases since then. Sure we might have more drops, but regular investing in great stocks over the long haul will ensure you are buying those stocks on the cheap. I don’t believe trying to outguess the market in the new economy is the answer, you will lose every time.

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Neil December 9, 2011 at 1:05 am

Well said – I once used a “money manager” to manage my stock portfolio because I thought maybe they knew something I didn’t. What they “knew” was that they would collect their “1% of assets fee” no matter if the portfolio went up or down. After paying their fee for 2 quarters of negative returns I had had enough and pulled my account – I’ve never looked back. I now make all my own investment decisions and if I lose money, fine, but at least I’m not paying an “asset management fee” on top of the losses. I’m also using a WellsTrade (Wells Fargo) account that gives me 100 free trades / year, so my trading costs are $zero.

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Sharon Thoms January 26, 2012 at 11:16 pm

Hi great article, very well written. You have got me thinking and especially the idea of saving money to take advantage of compound interest. Even if having to move to a smaller place to do it. Wise advice thanks.

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Joe May 21, 2012 at 11:04 pm

10% return? Where? Which Bank can provide you with a 10% return? As with Stocks, which stocks provide you with a 10% return on your Dividends? I am confused, as it’s a very high level generalization.

I agree, save each week into the Bank and the compounding effects work, but I cannot remember the past 20 years where you could earn 10% per annum frequently. I remember interest rates between 2% to 8%, but not 10%.

As well, did you take into account the Tax you pay each year on your Interest gains? After tax, the returns are a lot lower, unfortunately.

I like to use Facts, and not Generalizations. If anyone wants to be a millionaire, it takes hard work and a good savings plan. There aren’t any real tricks or anything. A little patience also helps as well.

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