Welcome to my Diversified Funds or DIY Investing analysis. Today I’ll be discussing the key differences between investing in diversified funds and utilising a DIY (do it yourself) investing approach. I’ll cover the pros and cons of both approaches and help you identify which one is better suited to your investment style.
A diversified fund is an investment fund that contains a broad spread of underlying holdings. These underlying holdings track different markets, sectors and asset classes. As such, they offer a convenient way of diversifying. Diversification is an investment strategy that ensures that you aren’t overly concentrated into a single area. This reduces the chance of portfolio volatility and provides more reliable returns. For these reasons, diversified portfolios are commonly sort after by investors. In the case of diversified funds, they provide a very simple and efficient way of gaining diversification due to the wide spread of their underlying holdings.
A DIY investing approach is when you actively choose your own portfolio holdings. Rather than selecting a diversified fund that has pre-allocated holdings at set percentages, the DIY approach enables you to customise your holdings. This requires the investor to take a more active role, as they have to physically select and rebalance their investment portfolio. However, it is useful for investors who want specific holdings and asset allocations.
The main appeal behind diversified funds is their convenience. As these funds contain multiple underlying assets, investors only need to make a single purchase to gain diversification across various markets, sectors and asset classes. Additionally, the holdings are pre-allocated, meaning that investors don’t need to work out their holding allocations. A benefit for this approach is that investors are less susceptible to human error, as they can’t FOMO into one holding or panic sell another one, as they are all comprised within the fund.
Subsequently, investors of diversified funds do not need to rebalance their portfolios, as it is done automatically. This frees up time by removing the need to analyse different markets, determine asset allocations and manually rebalance holdings. As such, beginners, passive investors and people looking to minimise time focussed on investing will likely gravitate towards diversified funds.
One of the main drawbacks with diversified funds is their fixed allocations. While fixed allocations can mitigate against human error, they can also predispose investors to unwanted or underperforming assets. For example, the popular diversified fund VDHG contains bonds which a lot of growth-oriented investors tend to avoid.
Similarly, DHHF while not containing bonds, has a relatively high allocation to emerging markets. Emerging markets have traditionally been relegated to small allocations in investor portfolios due to their volatility. Similarly, the percentage allocation of these underlying holdings is also fixed. This makes diversified funds less malleable than a DIY approach, as you can’t change the holdings or their allocations over time.
The main appeal behind the DIY approach is the flexibility. Investors can directly choose each of their investments. This ensures that the investor only gains exposure to assets, markets and sectors that they want to invest in. Similarly, they can set their own allocations, so that they gain as much or as little exposure as they deem necessary.
This flexibility in allocations is useful over long-term investment horizons, as investors may wish to gain more exposure to defensive assets as they near retirement. Alternatively, a new investment product may be released that the investor would like to add to their portfolio. Another benefit is that a DIY approach often has less MER than diversified funds. As such, investors who want to take a more active role with their investments will gravitate towards this approach.
One of the main drawbacks from the DIY approach is how much effort it takes to manage the portfolio. This approach requires constant research into the underlying holdings, determining appropriate asset allocations and manual rebalancing. Investors need to ensure that holdings don’t overlap and also need to make more frequent purchases compared to diversified fund investors.
As such, the complexity behind the variables associated with DIY investing often deter investors, particularly beginner investors and passive investors. Another issue is the potential for human error. Emotional investors may panic sell assets that are experiencing short term drops, resulting in a net loss on their investment. Contrastingly, they may also panic buy assets that are experiencing short term rallies before they correct. As such, beginners, passive investors and people prone to emotion are more suited to diversified funds.
Diversified funds provide a simple, convenient and cost-effective way of diversifying into a range of different assets. They are automatically rebalanced and require minimal investor involvement, freeing up time for investors. This comes at the expense of higher MER and these funds having fixed allocations.
These fixed allocations may contain exposure to holdings that you otherwise wouldn’t invest in. It also means that you can’t increase or decrease the funds underlying holdings without resorting to a DIY approach. As such, diversified funds are suited to beginner investors, investors who don’t want to take an active approach and people who are happy with the underlying holdings.
The DIY approach allows investors the ability to select their own portfolio and change their allocations over time. This malleable approach enables investors to increase, decrease and replace their holdings. Another perk is that the MER for a DIY approach is typically lower, as it’s on the investor to rebalance their portfolio instead of the fund manager.
However, this approach requires a lot more time researching the underlying holdings. Additionally, investors using a DIY approach have to manually rebalance their portfolios over time and will need to make more purchases. The active nature of DIY can also result in human error, due to things such as personal bias, panic selling and over-concentration. As such, DIY investing is suited for knowledgeable, level-headed investors who want to take an active role in selecting and managing their portfolios.