My finances, my projects, my life
March 31, 2023

DIY investment – is it a good idea?

The research is very clear, we attach more value to something we’ve made ourselves – a homemade cake, furniture that requires assembling, and even an investment portfolio. But is it really a good idea to do it yourself when it comes to your finances? If you have constructed your own portfolio, is this a strength or is it likely to bias your judgement?

The vast majority of us have made something out of Lego, built a piece of IKEA furniture or created an origami model. These are just three examples of the trend to “do it yourself”. DIY is more than just a fad, it is a real tidal wave that many brands are riding. Scientific research consistently shows that consumers appreciate this feeling of pride that comes from having made something with their own hands.

But there’s a flip side to this feeling. We are more attached to goods that we have made, but we are also biased when it comes to assessing their true value. In behavioural economics, this bias has been named the IKEA effect after the famous chain of Swedish furniture stores which understood the strength of the marketing argument behind DIY.

We are more attached to goods that we have made ourselves, but we are also biased when it comes to assessing their true value.

This effect was documented for the first time in 2011 by the famous behavioural economist Dan Ariely and his colleagues. Not only did they prove the existence of the IKEA effect, they also showed that it applies to a wide variety of areas.

Even before the theory was developed, the IKEA effect had been exploited by brands in the 1950s when instant cake mixes were introduced. These cake mixes were not immediately successful as their primary target – housewives – found there was not enough work involved to generate the desired result. Although the cakes were thought to be tasty and delicious, the process was not satisfying enough for those baking them. The manufacturers’ solution was to raise the level of involvement during the preparatory stages, for example, with the manual addition of an egg. As a result, this level of personal involvement was sufficient to ensure the product’s success and this remains the case to date!

The IKEA effect – it makes us feel effective and justifies our efforts

We have a psychological need to believe we are competent and able of carrying out the tasks entrusted to us. We thus overvalue things that gives us a positive image of ourselves. And this is precisely the case with DIY. When we build a piece of furniture ourselves or make a cake, this not only strengthens our feeling of personal effectiveness but also gives us the impression of being in control of our lives. For this reason, we tend to consider things that we have assembled as having much more value than is actually the case.

This overestimation of value is also linked to the mechanism of effort justification. When we spend time and expend effort on achieving something, we like to believe that the fruits of our labour have a high value, even if this is not always the case.

When we spend time and expend effort on achieving something, we like to believe that the fruits of our labour have a high value.

In principle, there is nothing wrong with wanting to do things ourselves and being proud of our work. But it’s important to remain realistic about the results and remain vigilant of the potential for marketing professionals to exploit this IKEA effect. It is often associated with cognitive biases such as overconfidence, overestimation, excessive attachment and excessive optimism.

Faithful readers of myLIFE will certainly have recognised the explosive ingredients in this list that can lead inexperienced investors to make investment errors under the influence of raw emotions. Does this mean you should avoid putting together your investment portfolio yourself?

The IKEA effect in investment

It’s useful to know how to recognise the IKEA effect when we buy a product in order to be sure we’re getting a good deal; it’s also important to know whether we can be hoodwinked by this effect when investing. This is particularly relevant, as it has never been easier to construct your own portfolio. Managing our own investments has become very popular with young investors thanks to digitalisation, but older people have also changed their habits since the lockdowns during the COVID-19 pandemic. Is this a cause for concern?

Researchers have analysed the IKEA effect in people managing their own investments. A study published in 2022 analysed whether constructing your own investment portfolio leads to the IKEA effect and, if so, what the impact could be on investment decisions. The study was carried out among a sample of 500 participants of all ages with an even split of men and women.

The experiment showed that participants who had constructed their portfolio themselves were more attached to it than to a similar portfolio that had been provided to them. However, researchers did not find significant differences in investors’ assessments of self-assembled portfolios and portfolios constructed by others. The strength of the results even allowed researchers to conclude that there is not an economically significant IKEA effect with financial portfolios. Participants were not biased about the fundamental quality of a self-assembled portfolio (i.e. about its expected risk/return) and there was no psychological effect related to the DIY phenomenon that could result in overestimating the portfolio.

Self-assembly significantly increases the subjective attachment of investors to their portfolio but does not bias their assessments or trading decisions.

Self-assembly significantly increases the subjective attachment of investors to their portfolio but does not bias their assessments or trading decisions. At first glance, this may appear surprising, but a financial portfolio is not the same as other goods.

An intangible means to an end rather than an end in itself

A financial portfolio is an intangible item and this makes it more difficult to use it to show off our abilities to others. It’s difficult to show off a financial portfolio as evidence of your abilities the way you can with a prominent piece of furniture in your living room or a cake you put on the table.

Furthermore, financial portfolios are rarely an end in themselves, they are part of the category of goods referred to as intermediary and utilitarian. They are a means of obtaining or achieving something else. It has been established that goods that are used as a means of achieving another objective are more likely to be the subject of more rational decision-making.

On this basis, we could be tempted to conclude that self-assembled portfolios represent an appropriate tool allowing investors to personalise their investments. They could even act as a useful tool for learning and increase the level of participation of individual investors on stock markets, without necessarily causing a negative temporary valuation. Heightened attachment to a self-assembled investment portfolio is not negative in itself. However, before drawing any hasty conclusions, there are two downsides to consider:

    • the experiment was conducted among a diverse population, but all participants already had previous investment experience;
    • there are many other cognitive biases likely to influence an investor’s decision-making and many good reasons to seek support from investment professionals.

DIY investing is not for everyone. Before taking a decision it’s worth weighing up the pros and cons. We also recommend that you take the time to talk to your banker to properly assess all the options.

DIY investment: the pros and cons

It is possible to construct your investment portfolio yourself, providing that:

    • you have a good level of financial education or are willing to take the time to acquire this;
    • you consider your portfolio as a means to an end and not an end in itself, otherwise you may be biased in your perception of its real value;
    • you are not subject to an excess of confidence or optimism and are aware of the cognitive biases likely to influence your decisions;
    • you enjoy seeing the results of your own efforts.

Constructing your investment portfolio yourself is not recommended if:

    • you want to show off your portfolio like a new car (the demonstration effect clouds our judgement);
    • you are a novice investor;
    • you are not willing to invest time and effort into learning.

In any case, it’s always a good idea to seek the help of professionals if you don’t have the necessary knowledge and experience to manage your investments alone.