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The Worst Form of Due Diligence


Due diligence is an important process for every investor to complete.  The purpose is to analyze whether a new investment or advisor is properly suited to your individual needs.

Most people want to believe that their situation is pretty much like everyone else’s.  They want to fit in a style box at a robo-advisor and have been told to pay as little as possible for their investments.  That’s fine up until the point where you realize that maybe your situation requires some specialized knowledge or you want to invest your money using unique tools. 

Proper due diligence should be a very up-close examination that includes two-way dialogue or the ability to glean as much data as possible from all available sources.  This type of evaluation should be completed based on your personal experience, goals, and risk tolerance.

The absolute worst form of due diligence is the following:

Spending 10-minutes on an advisor’s website and asking them to send you a 10-year track record. 

Let me break down all of the ways this doesn’t make sense.

1. An advisors’ website can be built and run by anyone. It’s a way to make an introduction.  However, it won’t tell you the little details of how they manage money or what they will do for your individual situation.  You have no idea if the person on the other end of this thing is an investment genius or a slimy salesman with zero knowledge of proper portfolio construction.

Advice: If you are interested in an advisor’s methods, setup an appointment to meet with them in person or via phone.  Have a list of questions that you want to get answered in that meeting (here are a few if you need help).  Be open and social with them.  If you are truly going to consider this person to manage your wealth, you should get to know them as much as possible.

2. Past performance is no guarantee of future results. Do you think the next 10 years will be anything like the last 10 years?  If so, come see me after class.  The decade to decade movement in the financial markets unfolds in a unique way every single time.

Advice: Stop thinking in terms of what happened over the last 10 years and start worrying about what is going to be the best strategy for your money over the next decade.  You are starting from a much different place with better tools and more knowledge than ever before.  It will be different this time.  It’s different every time.

3. A track record doesn’t tell you how an advisor actually manages money. It won’t stipulate what investments they used, what fees they charged, and what drives changes to the portfolio.  It won’t tell you if they have an actual process or are just flying by the seat of their pants.

Furthermore, you won’t be able to compare their returns versus any kind of benchmark unless they provide one for you.  How would you even know if their strategy is relevant to your needs without the current makeup, asset allocation, and other pertinent factors?

Advice: As a follow-up to an actual non-internet conversation (scary I know), ask them to show you their portfolio and provide you with some information on recent changes.  Compare their outlook with your own to decide if you share similar philosophies on investing, managing risk, etc… It’s all about finding the right fit, not the right performance.

The Bottom Line

I know many investors and experts will argue that a track record is the only pure data we have to compare strategies against.  I’m not here to discount that line of reasoning.  I’m simply pointing out that if your first questions are about track record and fees, then you are already doing it wrong.  Take the time to learn the landscape and ask pertinent questions to put your mind at ease.

There is no such thing as a perfect investment advisor or process.  However, you can greatly reduce the odds of making a mistake by instituting a reasonable path to learn how they achieve their results.

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Comment   |  3 years, 4 months ago from Irvine, CA