It’s no secret that Google’s search function yields a wealth of information associated with nearly every facet of finance. A search with the words “financial planning” will reveal more than a billion items to explore. While investors can immerse themselves in this sea of information, they may find that practical wisdom is in short supply.
The unfortunate reality of this information overload is that it is very difficult for the average person to decipher good information from bad. There are no disclaimers or flashing warning signs on web pages to let you know whether the authors are truly knowledgeable about their subject matter. Just as there is “fake news” on many Facebook feeds, there is plenty of bad financial advice shared all over the Internet.
While the effort to educate oneself on all things finance and investment related is applaudable, be aware that such activities can be plagued by inaccurate information, inappropriate applications and downright pitfalls that can lead to the loss of wealth.
The Cost of Bad Advice
Investment advisors must pass certain exams and meet criteria for both industry certification and state licensing requirements. Moreover, it takes years of experience to become a well-rounded, well-informed advisor. It usually helps to have lived (and invested) through some market downturns to truly understand the relationship between risk and reward.
Even with education and experience, investment advisors — and investors who make financial decisions on their own — can make miscalculations that put assets at unnecessary risk. Many a portfolio has been reduced as the result of expensive investment and/or administrative fees as well as tax and estate planning blunders.
“You must first focus on the return of your capital, and only second concern yourself with the return on your capital.”
First and foremost, even if you choose an investment advisor based on a personal referral, it’s important to conduct your own due diligence to ensure he or she is licensed and knowledgeable and does not have a “checkered past.” To investigate a prospective advisor, consider tapping the following resources:
BrokerCheck – a searchable database from FINRA
Investment Adviser Public Disclosure – a searchable database from the Securities and Exchange Commission
Evaluate Your Investment Decisions
Once you are confident in the knowledge, experience and trustworthiness of your financial advisor, your job is not over. Even if you don’t have time to learn all aspects of investing, it’s a good idea to evaluate the recommendations and strategies you and your advisor develop for your portfolio.
To help perform this evaluation, ask yourself the following questions.
1. Will this investment help me achieve my personal and portfolio objectives?
At the end of the day, portfolio strategy for many people isn’t about return of investment but rather meeting personal goals. For some, that’s about achieving the lifestyle they want and continuing it throughout their lifetime. For others, it’s about leaving a legacy. Every person is different. That’s why one of the first things a financial advisor will do is ask questions about your family, your finances and your goals for the future. Once your investment strategy is established, revisit these goals to evaluate if your chosen path is likely to get you there, if the path is likely to be smooth or bumpy and if you’re comfortable with that level of risk.
2. Does this investment option make business sense?
If it sounds too good to be true, it often is. This is a particularly important question if you’re inclined to act on a “hot tip” — be it from your broker or your golf partner. At any point, a stock tip might be a good idea, but there are lots of screens through which you should evaluate that investment. For example:
Do the company fundamentals (e.g., earnings, valuation) support it?
Is the overall industry or sector strong, or is this one investment an anomaly?
Does the level of risk of this investment complement the rest of your portfolio?
What is the likelihood of this investment meeting its projected performance within the current market and/or economic environment?
3. Is this investment aligned with my risk profile and timeline for meeting my objectives?
A wealth manager may attempt to quantify an investment strategy through a complex series of measures, such as the efficient frontier or modern portfolio theory. But for the layperson, consider whether an investment will reduce your portfolio’s risk or potentially raise its return. Ideally, it will do one or both.
4. How might I lose money with this investment?
It’s important to identify, from the outset, all the major risks associated with a particular investment or strategy. These may include market risk, credit risk, interest rate risk, inflation risk, foreign currency risk, foreign market risk (e.g., lack of regulation; social, political or economic instability) and liquidity risk.
Also evaluate your personal circumstances by determining how much money you can afford to lose. One way to manage your risks is to diversify investments and/or include financial products that provide guaranteed income.
5. What is my exit strategy?
Buy and hold is a tried-and-true strategy, but it should be periodically reviewed. Company management and fundamentals change. Industries change. The economic environment and market conditions change. Investor goals change. Once you establish specific objectives for your portfolio, it’s important to monitor performance against periodic benchmarks to gauge whether those investments are meeting them.
An exit strategy can be a minimum distribution plan, reverse dollar cost averaging, annuitizing, the outright sale of assets or transferring/rolling over to more conservative holdings. How you exit may depend upon your investment strategy, but it’s a good idea to consider how you plan to tap your investments once you reach your goals.
Many folks have expertise and knowledge in their respective fields, as well as plenty of life experience. The same can be said for most investment advisors. Often the best way to create an investment strategy is to combine professional financial advice with our personal understanding of what’s at stake and good old common sense.
It’s your money. If an investment recommendation triggers red flags that make you uncomfortable, ask your advisor to consider other options. There is a vast and complex world of investment advice out there; more than a billion sources to explore. You should feel confident that your advisor understands not just your investment goals but also your comfort level with the risks you take with your money.
The more you learn, the more confident you will be about your investment decisions.