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Investing is very important if you want to fight inflation and get returns on your saved money. But there are many ways to invest. Some of these ways are very simple, while others are complex.
But with simplicity comes higher fees. If you want the lowest price possible, you will need to get more control, and thus complexity. You will need to find the perfect balance for your needs. Not everybody will use the same investing level.
In this article, we see what I call the four levels of investing. It is essential to know what the other ways of investing are. Each of these investing levels has pros and cons.
Level 0: Not investing
Let’s start with investing level 0. At this level, you are not investing at all.
It is not an investing level since you are not investing. But by not investing, you are missing out on a lot of returns.
So, while you do not have fees at this level, you will still have a significant opportunity cost. You are missing out on all the returns of the stock market (or any other investing market).
It is difficult to know how much control we have at this level. But I would say that we have a lot of control since we can do anything with our money and choose to do nothing.
Investing Level 0 is easy to summarize:
- No fees
- A high opportunity cost of -5% per year
- A high level of control on your assets (but nothing to control)
Level 1: Investing with a bank
Let’s continue with something a little more interesting: Investing with a bank. At investing level 1, you are investing your money with the services of a bank.
Compared to level zero, you will have your money invested in the stock market. And for the sake of simplicity, we will assume that the bank will provide the same returns that of the stock market. In practice, they may not perform at the same level as the stock market. But let’s ignore that for now.
When you invest directly with a bank, you have little control. With a bank, you can only choose a few funds. And most of the time, they will propose you some limited choice. And most clients will be content with this limited choice.
Of course, you can still choose how much you want to invest. But you cannot choose precisely what funds you are investing in since the choice is limited. With some banks, you may have a good choice of funds. But overall, the choice of banks is likely to be limited.
Now, this also means that it is straightforward to invest with a bank. In most cases, you can click a simple button on a web interface, and they will move the funds from your savings account into your funds. You can see the results of your funds each day but usually not during the day.
Now, with this simplicity comes a great price. The fees for investing with a bank are very high. In general, banks will offer you access to active funds with pretty bad conditions. Why is that? Banks are making more money with these kinds of funds, so this is what they offer.
If you invest in the funds proposed by your bank, you can expect between 1% and 2.5% in fees per year. On average, in Switzerland, you will pay about 1.5% fees per year on your managed assets. I am including here all the fees (transaction fees, bank fees, fund fees, redemption fees, …).
I am not talking about personal banking. I am talking about using the investment services of your bank. Private banking is where they will personally manage your money. In that case, the range of investments is much more varied. But personal banking is generally reserved for very wealthy individuals.
For me, the biggest problem with these fees is that most people do not even know that they are paying them. I am pretty sure that most people investing with a bank do not adequately research the funds the bank is proposing. And often, these fees are not very transparent. There are many different fees, and you need to take them all into account.
I made this same mistake when I started investing with my bank. Most people do not have the financial education necessary to understand these funds. And a lot of people are trusting their banks too much.
But the advantage is really in simplicity. Investing in a bank is very simple. It is a good way not to stress about your investments.
Let’s summarize Investing Level 1:
- High fees: Average of 1.5% fees per year
- Average stock market returns
- Very little control over your assets
- Very simple to invest
Compared to level 0, we have entirely removed the opportunity cost. On the other hand, we have introduced high fees on the assets to get average stock market returns. Finally, we have very little control over the way we invest our assets. However, we have a very simple way to invest.
Level 2: Investing with a Robo-Advisor
Investing Level 2 is when you are investing with a Robo-Advisor. Instead of trusting a banker to manage your assets, you trust a Robo-advisor to manage your assets.
The main difference is that you will not talk to a real advisor, but you will give information to a machine that will prepare an investment portfolio for you. And then, you will be able to wire money directly to your account. And this money will be invested following the portfolio chosen by the machine.
With this investing level, you have a slightly higher level of control. Indeed, most Robo-advisors will let you do some customization of what you want to invest in. Some services give you a nice amount of control while others give you very little. But in the end, you still have more control than when investing with a bank.
The main advantage compared to investing with a bank is the reduction of the fees. Indeed, Robo-advisors are cheaper than paying for the services of a bank. However, they are still not cheap, at least in Switzerland. You can find Robo-Advisors with between 0.8% and 1.2% in fees per year. On average, we can take a 1% fee per year for Robo-Advisors. Ideally, you will try to choose a cheaper one. But that is up to you.
Regarding the fees, there is another advantage compared to banks. Robo-Advisors are more transparent. You can generally see a complete picture of the fees. Banks have many hidden fees. So, people are often surprised when they know how much they are paying.
Depending on the Robo-advisor, the investment strategy may be very different. Some Robo-advisors invest in single stocks chosen with complex models while others simply invest in index ETFs. Depending on the service, they could give you more or less control over the strategy.
Let’s summarize Investing Level 2:
- Medium to High fees: Average of 1% fees per year
- Medium to little control over your assets
- Average stock market returns
- Very simple to invest
Compared to Level 1, we have reduced the fees significantly, although they are still not negligible. On top of that, we have added a little control over the assets and added a little extra complexity. But this investing level remains simple.
For more information on this level, read my article on Robo-Advisors.
Level 3: Investing yourself (DIY)
Investing Level 3 is when you are investing by yourself, also called DIY investing.
At this level, you will directly use a broker account to buy shares of funds (or ETFs). This investing level offers the highest level of control over your assets.
Since you have a lot of control, you can minimize your fees a lot with this form of investing. First of all, you can choose the cheapest broker. With this, you will minimize your custody fees and transaction fees. Then, you can also choose the best funds for your needs. By doing so, you will reduce the management, redemption, and issuance fees.
With this control, you can get fees that are much lower than the other investing levels. On average, you can easily go down to something like 0.3% of fees per year. And if you go all the way, you can go down lower than that. And investing fees are important. It is the reason why many people invest themselves.
Now, if you ignore the fees, DIY Investing can be expensive. If you are investing with a costly broker and are investing in expensive funds, Investing Level 0 may well be as expensive as the other levels. So, while it has a very high potential for low fees, it also has the potential to be as expensive as you choose it to be.
For some people, more control is not always a good thing. Having more control also means being able to make more mistakes. Many people investing themselves let their emotions do the investing. And in the end, they could lose a lot of money.
Also, with so much control comes complexity. You will have to learn many things about investing before you can invest yourself. And you will have to make many important decisions as well. First, You will have to choose your investment portfolio. Once you have chosen your portfolio, you will have to choose all the funds necessary for the portfolio. And you will also need to learn how to use your broker.
So, while this investing level gives you a lot of control, it also gives you a lot of complexity. Some people think it is too complicated for them. I do not believe it is the case. If you do your research correctly, it is not that difficult. However, it requires some dedication to learn the necessary things before you get started.
And it also requires some nerves not to let your emotions invest for you. At this level, you have all the control. So, you may sell or buy shares very quickly. If you are not sure you will not do such mistakes, you should maybe stick to the other levels.
Let’s summarize Investing Level 3:
- Low fees: Average of 0.3% fees per year
- Very high control over your assets
- Average stock market returns
- Comprehensive learning necessary for this investing level
Compared to level 2, we have significantly reduced the fees. But we also have greatly increased the complexity and the things you need to learn. And you will have more opportunities to make mistakes.
To invest, you need to choose the right balance between fees and control. Each investor has different needs and so may choose a different investing level.
For instance, when deciding to invest with a bank, you need to know that you will pay a lot of fees for the convenience of investing simply. Maybe you could consider moving to the Robo-Advisor Investing Level. Doing so would reduce the fees and let you have a little more control over your assets. But this change would be at the expense of some simplicity.
Keep in mind that the order of these investing levels is based on the fees you will pay. It does not say how good or how bad one investing level is.
There is nothing wrong with not investing yourself. However, DIY Investing is not for everybody. And I completely understand people that decide to go with a Robo-Advisor. These people need to know the drawbacks of investing like this (fees!).
It is interesting that these levels also influence how much time it takes to invest.
If you are stuck at Investing Level 0 and do not know where to start, start with my guide on how to get started investing in the stock market.
What about you? Which investing level do you use?