Once upon a time, only a limited number of people invested in stocks. Most people had exposure to the stock market through mutual funds their 401(k)s invested in, and only people with significant means and wealth preferred leveraging the services of investment managers. Hefty brokerage fees were another barrier that kept people from investing in stocks.
It changed when platforms like Robinhood started offering no-commission trading and motivated people to become DIY investors. If you also want to take control of your savings and investments, there are two ways of investing you need to know about: Self-directed trades vs. Robo-advisors.
Self-Directed Trades
Self-directed trades are when you buy a stock, an ETF, or even a digital asset using a trading platform without going through an intermediary (an investment broker). These trades are easy, virtually free (apart from a few small transactions or fund fees), and they allow you complete control over your portfolio management. You have control over which assets you can buy and when, and where you place them (in a self-directed IRA or 401(k)).
There are some pros and cons of self-directed investments you should understand before choosing this path to prosperity.
Pros
- Complete control of your portfolio management as asset allocation.
- Minimal cost of investment.
- You can fine-tune your portfolio for your risk tolerance and return goals.
- You have more control over your liquidity.
Cons
- You need investment knowledge and experience to make the right investments.
- If you can’t buy and sell at the right time, you won’t get the best value or prevent your portfolio from dipping.
- You are likely to lose money in the learning phase.
- You will need to conduct extensive research on any asset you are thinking of buying.
- It will require you to be more actively involved in the investment process.
A lot of risks associated with self-directed trades can be eliminated by focusing on broad-market index funds that offer lower but relatively more predictable and consistent returns.
Robo-Advisors
Robo-advisors are automatic, algorithm-driven investment tools that create an investment portfolio (mostly made up of low-cost ETFs) based on your risk tolerance and investment goals. Robo-advisors make investing hands-off and relatively easy for beginner investors. Robo-advisors come in different forms, levels of complexity, and features. Some offer a rudimentary set of portfolios; others offer better returns by focusing on individual stocks.
Many of them offer re-balancing, which means the Robo-advisor automatically adjusts your portfolio every month, quarter, or year (or as needed) to realign with your investment goals.
Pros
- Hands-off investing.
- Doesn’t require any special investment knowledge.
- Can offer much better returns through proven strategies.
- Robo-advisor portfolios are adequately diversified for better risk mitigation.
- Minimal cost-barrier.
- Advanced features like rebalancing and tax-loss harvesting can produce a radical difference in long-term returns.
Cons
- It comes with fees (although they are quite low compared to human investment managers).
- Limited asset classes (most robo-advisors only set a fixed set of ETFs).
- You have limited to no control of your investment selection.
- Returns might only be as good as the technology/algorithm behind the stock selection.
Conclusion
Both Robo-advisors and self-directed investing are good options. The right solution for you will depend upon your circumstances, investment acumen, and willingness to learn more about investment.
