What Type of Individual Investor Are You?

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During the past few weeks, we’ve been discussing stocks, bonds and asset allocation strategies. This week, we’re going to focus on something more tactical: who is responsible for implementing the allocation strategy and managing your portfolio? Are you going to do it? Are you going to hire an adviser to help you? Are you going to use mutual funds instead?

For dyed-in-the-wool do-it-yourself (DIY) investors, the answer is obvious: They want to make all of the decisions. Others take comfort in having a professional manage their portfolio. In between, there is a wide spectrum. I’m going to discuss this spectrum while we create a framework to help you determine where you are on the spectrum.

I’ll start with a fully hands-on investor. This type of investor likes to handpick the stocks and bonds matching their allocation strategy. An investor who follows this approach has the time and interest to research individual securities. Successful ones have the discipline to adhere to a systematic approach for carrying out such a strategy and adjusting their portfolios as necessary. This type of approach requires enough wealth to hold a diversified portfolio of securities.

A partially hands-on investor combines holding individual securities with mutual funds, exchange-traded funds (ETFs) or closed-end funds. This investor owns both individual securities (most commonly individual stocks) and funds. An example would be an individual investor who picks their own stocks but uses mutual funds or ETFs for the bond portion of their portfolio. The approach requires less wealth and less time relative to the fully hands-on approach. It also offers greater diversification among individual securities.

Those of you participating in 401(k) plans or similar defined-contribution plans offered by your employer may be following this type of approach without thinking about it. You could hold individual stocks in your IRAs and traditional brokerage accounts, while holding mutual funds in your 401(k) account. Even though your workplace retirement plan choices are limited to a specific set of funds, you are still making the active decision of which funds to hold.

The index investor prefers index mutual funds and ETFs over individual securities. They view passive strategies as advantageous. The wealth requirement to follow this is very low. The amount of time required to follow such a strategy after an allocation strategy is decided upon is limited to selecting the appropriate funds, periodically monitoring them for any changes (e.g., a switch in the benchmark index followed) and reviewing the portfolio on a set schedule to ensure the allocation targets are being maintained. This approach has among the lowest costs but cedes control over the securities chosen.

The fund investor is similar to the index investor with the exception that they consider owning actively managed funds. This type of investor is either hoping to outperform the market and/or takes comfort in knowing a professional portfolio manager is choosing the investments and (potentially the allocation). It can also be unintentionally followed, such as when an actively managed target-date fund is the default investment option in a workplace retirement plan. The strategy requires less time and wealth than the fully hands-on or partially hands-on approaches but can require closer monitoring than the index investor approach and has a higher ongoing cost.

The combo hands-on/works with an adviser investor combines using an adviser with personal control of investments. This type of investor hires a financial professional—such as a financial planner or a financial adviser—to provide assistance with carrying out their investment strategy. A fee-only planner might be used on a periodic basis to assist with the portfolio review process to ensure the allocation strategy chosen matches current goals, or to simply provide objective feedback and consultation. A financial adviser might be hired to select investments. Alternatively, a portion of the portfolio might be given to a robo-adviser to be managed, while part of the portfolio is self-managed. This type of approach works best for those who want some personalized assistance while still making their own investing decisions. The level of wealth required depends on the amount of assistance sought and the type of professional hired (e.g., a fee-only financial planner could work well for those seeking consultation and feedback, but not specific investment recommendations). This type of approach can save time but comes with potentially higher costs—especially if a traditional (non-robo) financial adviser is hired.

A twist on this combo approach is a bolt-on approach. This involves working with specialists to address specific tasks. For instance, a life insurance agent could be contacted for the purchase and management of policies. Alternatively, a tax professional or estate attorney may be warranted. A good fee-only financial planner or financial adviser may be able to serve as a hub for providing recommendations to these types of specialists and, for those with complex financial and estate-planning needs, coordinating their recommendations.

The adviser investor hires a professional to carry out their allocation strategy. This investor outsources the process of implementing and managing their allocation and investment strategy. It can make sense for those who lack confidence, knowledge and/or the time to make their own investing decisions. As one ages, turning over management of investment decisions can a prudent decision though the selection of an adviser (or a trusted family member instead) should be done well before cognitive issues evolve. Robo-advisers would be a consideration for those with moderate levels of wealth and who don’t require much one-on-one communication. A traditional adviser makes sense if you have complex financial and/or estate-planning needs.

We’re planning on using these categorizations to create a worksheet to help you determine where you fit on the spectrum. So, tell us in the comments section below whether we’ve appropriately covered the spectrum.