Part 2: What Do Investment Managers Do?

In this instalment, we'll explore what it is an investment manager actually does and how investment firms work. Understanding this process is the first step in understanding the compelling reasons why you should consider becoming your own financial investment manager.

The Investment Paradox

Imagine a world where everyone has the power to manage their own investments. The financial industry, as we know it, would undergo a seismic shift. Banks, brokerage firms, and financial advisors would scramble to find new ways to maintain their revenue streams. This chapter aims to unravel the complex web of the investment industry and lay the foundation to empower you to take control of your financial destiny. We'll explore why the industry doesn't want you to manage your investments and provide a step-by-step plan to do so.

The Invisible Forces

The investment industry is built on the notion of expertise. Financial advisors and portfolio managers present themselves as gatekeepers of wealth, armed with specialized knowledge and insider access. But why does the industry cling so tightly to this narrative? The answer lies in the structure of incentives. Commissions, fees, and complex products all ensure that the financial ecosystem thrives on your dependency.

To understand the grip the financial industry has on individual investors, we need to delve into the psychology of dependency. Picture a world where the intricate dance of the stock market is deciphered only by a select few. This exclusivity creates an aura of indispensability around financial advisors and portfolio managers. The average investor is made to feel that without this guidance, they are destined to falter.

Consider the story of Jane, a mid-level executive in a large corporation. Despite her successful career, Jane has always been intimidated by the thought of managing her own investments. She relies on her financial advisor, who, for a hefty fee, promises to navigate the complex waters of the financial markets on her behalf. Jane's advisor speaks in a language filled with jargon and technical terms, reinforcing Jane's belief that she is incapable of handling her investments independently.

The industry thrives on this dependency. Advisors are incentivized to maintain the status quo through commissions and management fees. The more complex and opaque they can make the investment process appear, the more reliant clients become. This creates a lucrative cycle for the financial industry but leaves individuals like Jane perpetually dependent and often unaware of the alternatives.

The Power of Perceived Complexity

Like most industries, the investment world does have it’s own jargon, but this isn’t jargon that you can’t learn. In subsequent chapters of this book, we’ll put those terms into easy to understand words and soon you will see that it’s not actually the concepts that are difficult - just words that you don’t know the meaning of - yet. Terms like "alpha," "beta," "derivatives," and "arbitrage" are designed to create a sense of mystique and exclusivity. This perceived complexity discourages the average person from venturing into self-management. But the reality is that the core principles of investing are simple and accessible.

Take, for instance, the concept of alpha. In the investment world, alpha represents the excess return on an investment relative to the return of a benchmark or point of reference. Some benchmarks that you may have heard before are:

S&P 500 Index:

  • Comprises 500 of the largest publicly traded companies in the U.S.
  • Represents approximately 80% of the total U.S. equity market capitalization.
  • Widely used as a benchmark for U.S. large-cap stocks.

Dow Jones Industrial Average (DJIA):

  • Includes 30 large, publicly-owned companies based in the U.S.
  • Price-weighted index, meaning companies with higher stock prices have more influence.
  • Often used to gauge the overall health of the U.S. economy.

NASDAQ Composite Index:

  • Contains more than 3,000 stocks listed on the NASDAQ stock exchange.
  • Heavily weighted towards technology and growth-oriented companies.
  • Common benchmark for tech and biotech sectors.

But, if you haven’t heard of them before, don’t worry. While the term may sound esoteric, the principle behind it is straightforward: it’s about measuring performance against a standard. Similarly, beta measures an investment's volatility relative to the market - this just means how much the investment's price fluctuates compared to the overall market. 

Yet, these terms are often presented in ways that make them seem unattainable to the layperson. Financial advisors and portfolio managers use this complexity to their advantage. By maintaining a linguistic barrier, they create a dependency loop where the investor feels they cannot succeed without professional guidance.

This chapter aims to demystify these concepts and show that with a bit of effort, anyone can understand the basics of investing. The perceived complexity is a barrier constructed by the industry, but it is one that can be dismantled with education and determination.

The Tipping Point of Financial Self-Reliance

In the book "The Tipping Point," by Malcolm Gladwell, he explores how small actions can create a tipping point that leads to significant change. Similarly, small steps towards financial literacy can empower individuals to take control of their investments. Imagine if a critical mass of people started managing their own portfolios – the industry would be forced to evolve.

Financial self-reliance starts with education. The journey begins by understanding the basics: what are stocks, bonds, mutual funds, and ETFs? How do they work, and how can they be used to build a diversified portfolio? These questions are the foundation upon which financial independence is built.

Let's explore the story of Lisa, a teacher who decided to take control of her financial future. Lisa started small, reading books and articles about investing. She joined online forums, participated in webinars, and gradually built her knowledge base. With each step, Lisa’s confidence grew. She opened a brokerage account and began managing her investments. Her journey was incremental, but each small step brought her closer to financial independence.

Lisa's tipping point came when she realized that managing her investments was not only possible but also empowering. She no longer felt at the mercy of market fluctuations or dependent on her advisor's decisions. Instead, she made informed choices based on her understanding of the market and her financial goals.

Imagine if thousands of people followed Lisa’s path. The collective shift towards financial self-reliance would force the investment industry to adapt. Advisors would need to offer more value, focusing on education and transparency rather than perpetuating complexity and dependency. The balance of power would shift, empowering individual investors and fostering a more equitable financial landscape.

Understanding the Basics of Investing

Investment management often seems like a mystical realm, accessible only to the financial wizards on Wall Street. But the truth is, understanding the basics can empower you to take control of your financial future. In this chapter, we'll demystify the role of an investment manager, or portfolio manager, and explore how you can adopt their principles to become your own financial investment manager.

The Role of an Investment Manager

An investment manager, or portfolio manager, is a professional tasked with the job of managing an investment portfolio on behalf of clients. Their primary goal? To meet the client's investment objectives, whether that's growing wealth, generating income, or preserving capital. 

The investment manager you would usually speak with is more often than not not the one doing all these jobs. They are simply the salesperson charged with client communication, but they do have a team of researchers and analysts behind them and here’s what those people do.  

  1. Research and Analysis:
    • Imagine Sherlock Holmes with a Bloomberg terminal. Researchers and analysts dive deep into the world of stocks, bonds, real estate, and commodities, analyzing financial statements, market trends, and economic indicators to make informed decisions.
    • They balance both quantitative analysis (think numbers and stats) and qualitative analysis (think industry trends and company leadership) to evaluate potential investments.
  2. Portfolio Construction:
    • Based on their research, analysts help portfolio managers craft a diversified portfolio tailored to the client's risk tolerance, time horizon, and financial goals. Diversification is their secret sauce, spreading risk across different asset classes to mitigate the impact of any single investment tanking.
    • Asset allocation is the name of the game, determining how much to invest in each asset class. Picture a portfolio with 60% in stocks, 30% in bonds, and 10% in real estate.
  3. Risk Management:
    • Managing risk is like walking a tightrope. Investment managers employ strategies like diversification, hedging, and stop-loss orders to mitigate risk. They keep a vigilant eye on the portfolio to ensure it aligns with the client's risk profile.
    • Staying informed about global economic conditions, geopolitical events, and market developments is crucial. They’re always on the lookout for the next big risk factor.
  4. Performance Monitoring and Reporting:
    • Investment managers are like pilots checking their instruments. They regularly review portfolio performance, compare it against benchmarks, and assess if it meets the client's objectives. They provide detailed reports to clients, explaining the portfolio's performance and any changes made.
    • Periodic rebalancing is essential to maintain the desired asset allocation. This means selling overperforming assets and buying underperforming ones to keep the portfolio in line with the target allocation.

Step-by-Step Plan to Take Control of Your Investments

Now that we understand the forces at play and the power of financial self-reliance, let's delve into a practical, step-by-step plan to take control of your investments.

Step 1: Educate Yourself

The first step in managing your investments is education. Start with the basics:

  • Understanding Financial Statements: Learn how to read statements and understand the difference between book value and market value and is meant by a balanced and diversified portfolio. 
  • Investment Vehicles: Familiarize yourself with different investment options, including stocks, bonds, mutual funds, ETFs, and real estate. Each has its own risk and return profile.
  • Market Mechanics: Understand how markets function, including the role of exchanges, order types, and the impact of economic indicators.

We’re going to cover all this information in the following chapters. 

Step 2: Set Clear Financial Goals

Define your financial objectives. Are you saving for retirement, a child’s education, or a major purchase? Your goals will guide your investment strategy and help you determine your risk tolerance and time horizon. Write down your goals and create a roadmap to achieve them.

For example, if your goal is to save for retirement, calculate how much you need to save and what rate of return is required to reach that goal. This will inform your asset allocation and investment choices.

Step 3: Develop a Diversified Portfolio

Diversification is the cornerstone of risk management. By spreading your investments across different asset classes and sectors, you reduce the impact of any single investment’s poor performance. Start by:

  • Asset Allocation: Determine the mix of stocks, bonds, and other assets that align with your risk tolerance. For example, a common allocation might be 60% stocks and 40% bonds.
  • Investment Selection: Choose individual investments or index funds that fit your asset allocation strategy. Index funds, which track a broad market index, are a simple and effective way to achieve diversification.

Consider using a core-satellite approach, where the core of your portfolio consists of low-cost index funds, and you use satellite investments to add exposure to specific sectors or asset classes.

Step 4: Leverage Technology

Technology has democratized investing. Use online platforms and apps to:

  • Track Performance: Monitor your portfolio’s performance in real-time.
  • Analyze Investments: Access research tools and financial news to make informed decisions.
  • Automate Investments: Consider using robo-advisors for automated portfolio management and rebalancing. These platforms use algorithms to create and manage a diversified portfolio based on your risk tolerance and goals.

Apps like Robinhood, E*TRADE, and Fidelity offer user-friendly interfaces and a wealth of resources to help you manage your investments.

Step 5: Overcoming Behavioral Biases

Behavioral biases can undermine even the best investment strategies. Recognize common biases like overconfidence, herd behavior, and loss aversion. Develop strategies to mitigate their impact, such as setting predefined rules for buying and selling or consulting with a financial mentor.

For instance, overconfidence might lead you to take on too much risk, while loss aversion could cause you to sell investments prematurely. Being aware of these biases and having a plan to counteract them is crucial for long-term success.

The investment industry may not want you to manage your own investments, but the power to do so is within your reach. By educating yourself, setting clear goals, diversifying your portfolio, leveraging technology, staying informed, and overcoming behavioral biases, you can take control of your financial future.

As more individuals embrace self-management, we may reach a tipping point that transforms the financial landscape for the better. The journey to financial independence is incremental, but each step brings you closer to a future where you are empowered and in control of your investments.

The Benefits of Managing Your Own Investments

  1. Control Over Your Financial Future

Imagine having complete control over your financial future. You make the decisions about where your money goes, how it is invested, and what level of risk you are comfortable with. This control allows you to tailor your investment strategy to your specific financial goals and personal values. Better yet, imagine having the confidence, tools, and knowledge to fully take the reigns. 

When you manage your own investments, you align your portfolio with your long-term objectives, such as saving for retirement, funding your children's education, or purchasing a home. You are not reliant on someone else's judgment or subject to their biases, which means your investments can more closely reflect your financial aspirations and ethical considerations. Going through this process of identifying what your long-term objectives are might be one of the most important exercises you might undertake in your life. For example, understanding that what I really wanted was to have an island getaway home where I could spend my days writing was the fuel and the vision I needed to do the hard (but achievable!) work of learning how to achieve the same portfolio results with those management fees. And I, want the same for you.

  1. Cost Savings As we discussed in chapter one, financial advisors and investment managers typically charge fees that can significantly reduce your returns over time. Consider a portfolio of $100,000 with a 1.5% annual management fee; over 20 years, assuming a 10% annual return, this could amount to over $85,000 in fees. Imagine how much closer you will be to achieving those long term financial goals with those fees earning a rate of return for you in your portfolio instead of the investment management fee.
  2. Increased Financial Literacy Managing your own investments requires learning about financial markets, strategies, and economic indicators. But I promise you, it is nothing that you can’t learn. There’s no need to revisit calculus 12 or get a master's in economics. This process of learning will boost your financial literacy, and equip you to make informed decisions about your money. Additionally this enhanced financial literacy can benefit you in other areas of life too, from budgeting to selecting a mortgage or an insurance package.
  3. Flexibility and Adaptability Life is dynamic, and ever changing and your financial goals and risk tolerance may shift over time. When you manage your own investments, you have the flexibility to adapt your strategy as circumstances change. Whether it’s shifting your asset allocation or exploring new investment opportunities, you can make these changes quickly and efficiently.
  4. Personalized Investment Strategy Professional financial advisors often manage multiple clients, limiting the level of personalization they can offer. By managing your own investments, you can create a highly personalized strategy that considers your unique financial situation, risk tolerance, and goals. You can choose investments that reflect your interests, values, and preferences, making the process more engaging and rewarding.
  5. Empowerment and Confidence Taking control of your financial investments can be incredibly empowering. As you gain knowledge and see the results of your efforts, your confidence in managing your finances will grow. This empowerment can spill over into other areas of your life, fostering a greater sense of self-reliance and accomplishment.

Empower Your Wealth: Become Your Own Financial Investment Manager is a 20 part series that teaches readers how to self-manage their investments. It covers basics to advanced strategies, emphasizing the importance of financial independence, diversification, risk management, and technology

Back to blog