When it comes to analyzing an investment, what kinds of things do you look at? Do you read books, look in the newspapers, or use the internet? For most people, investment research is a very difficult process. While information is abundant and easily accessible, it is also excessive and confusing. Most investors have little to no clue as to where to start.
As a financial expert, I would like to give you some of my favourite investment research tips.
- Always take the time to understand risk. Every investment has some type of risk. For most investors, risk refers to the possibility of losing money. Other than guaranteed investments, most investments have the potential to lose money. The riskier the investment the greater the potential to lose money. Far too many investors tend to focus on performance, returns or the rewards of an investment instead of starting by understanding the risks of that investment. Before choosing an investment, make sure you understand some of the following:
- Can you potentially lose capital and if so, under what circumstances?
- How much capital could you lose?
- Is the investment insured?
- What is the worst-case scenario?
- What happens if the company goes out of business?
- Is there potential for fraud?
- Look at multiple periods of data. When it comes to quantitative research (studying numbers), it is very important to avoid something I call snapshot data. Far too often, I see investors look at one set of data when evaluating an investment. You see, I can show you two different sets of the same type of data but just at different points in time and you could come to two completely different conclusions. It’s no different than looking at two different pictures of the same thing taken at different times of the day and you have a completely different perspective of the object. The bottom line is to look at multiple periods of data to get a better understanding of the investment.
- Be aware of the fees and costs. Every investment has some costs associated with it. Some fees are very transparent like mutual funds. For other investments, you will have to dig really deep to try to figure out all the fees and costs. Be very cautious with investments when you cannot get a good sense for the fees. In most cases, the higher the fees, the worse it will be for the investor. However, it is equally important to know what you will be getting for those fees. It is very possible that higher fees can sometimes translate to a bigger benefit. Basically, it boils down to something I call value. Value to me is the benefit less the cost. The cost is only half of the equation.
- Know the tax implications of the investment. When investing money, it is not about how much you make but rather what you keep that counts. Imagine two investments that give you returns of 8% and 10%. Which would you choose? It’s not a trick question. Given this data, you would always choose the 10% investment. However, what if after taxes, the 8% investment becomes 7% and the 10% investment becomes 6%? Now, which would you choose? Every investment can have different tax implications. The smart, savvy investor always take the time to understand the after tax benefits.
- Know something about the company offering the investment. Often the quality of the investment comes from the quality of the company offering the investment. For me, knowing something about the company is simply a security blanket. It is that added dose of comfort if I know the company has been around for a while and has some track record. It does not mean that new companies are bad but rather that I need to do a little more homework for re-assurance.
These five tips are simply some of the essential parts in my research process; the list is far from exhaustive. My basic principle for research is that the more research you do, the more likely you are to make better investment decisions. Good research should incorporate a combination of quantitative data as well as qualitative analysis. In the end multiple dimension analysis will always be better than single dimension analysis. Research is not something you simply do once. Rather good research is an ongoing process.