Wednesday, January 21, 2009

Ethics and Due Diligence

I'm shocked by the number of investors I talk to who don't do due diligence or don't investigate further. What is also disheartening (but maybe not as shocking) is that people put complete faith in their financial advisers. You have to understand the quality of the advice you are given. If you aren't very knowledgeable about the market, here is some advice for choosing a good financial adviser:
  1. Know what their position is in the stocks they are recommending. Generally, I won't buy anything that my adviser doesn't already own (at a price similar to what I'm buying at).
  2. Ask what price they will sell at. If you buy, have a sell price ready. Don't become emotionally greedy. You can re-evaluate your positions, but understand what you're getting into. Also, this is a great lead in to the next question:
  3. Be aware of conflicts. Some advisers are market makers, part of an underwriting team or make commission based on trading volume or sales. This means that they don't really care if you make money or not (in fact they may never really want you to sell... At least until they've liquidated a signification position). Technically, according to CFA and CSC standards of ethics, advisers are supposed to disclose any conflicts, but often they don't. You aren't supposed to have to ask, but if you care about your money, you will.
  4. Track the performance of your adviser against relevant indicies or benchmarks. Just because the economy is down 30% doesn't mean that your portfolio should be too. Understand beta, correlation and market risk. Or if you don't, make sure your adviser does.
  5. Asset allocation. This is the boring part of investing as people tend to just gamble and shoot the moon when it comes to equities. But understand your financial goals and targets puts things into perspective. A smart CFP will usually sit you down and discuss your life style and retirement goals before even discussing equities. That's actually the *last* piece. The idea is to find investments suitable to your risk tolerance and time horizons. You may not think of this now, but you definitely will when you start to lose money in the short term (which is too late).
Advisers must be complete the Canadian Securities Course (CSC) or Series 7 in the US before they can sell securities products. Also, most firms require their advisers to become Certified Financial Planners (CFPs). Check out this great article on selecting a CFP and financial adviser.

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