Every time there's a scam that hurts investors, you find out that people didn't do their research. They invested because they read something in a newspaper, or a friend gave them a tip. A bit of effort working out just what they were investing in could have saved many investors from Bernie Madoff's ponzi scheme, for instance.
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| Do Your Research Before You Invest Your Money: eAskme |
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So where do you start?
Get the documentation - and read it. Whether you're investing in a mutual fund or a share in a company, there will be documentation available. Prospectuses and fund descriptions are full of legalese but they do also contain useful information - you just have to search for it. It's also worth getting documentation from other similar funds or companies to compare - do they give a different view of the market? Are there any significant omissions in the information? For instance, if a company doesn't mention a major disruptive change in its industry, that could be a bad sign - it's either missed the importance of what's happening (as Blockbuster did the arrival of Netflix), or it's trying to pretend it won't matter.Do the numbers. If you're investing in companies you really should build a spreadsheet to analyse the numbers. Look at the margins - profit as a percentage of sales - and compare them to previous years; if margins are being squeezed by cost pressures or falling prices, that's a bad sign. You'll also want to compare margins with other similar businesses. If they are way out of kilter it could be a sign that something's wrong either with the business, or with the accounting policies. You'll also want to do your own forecasting - it sounds difficult but it's fairly easy to do some back of envelope forecasting, thinking about the total amount of sales a company might make. For instance, how many cars would Tesla need to sell to break even? You won't get the right answer but just thinking about the issue will show you where companies and investors are being way over optimistic.
Look at the ratios. Some investors come a cropper because they invest in a great story but pay far too much. Always look at the price/earnings ratio which tells you how many years you'd have to hold the stock for the company to earn your investment back. You can look at the price/earnings ratios for a whole market index, if you're evaluating funds. Look at the dividend yield, if you're interested in income, and if you want to buy bargain basement, look at the net asset value - real assets that the business owns - and compare that with the share price. Services like Google Finance have the data you need.
Search out opposing views. Investors often fall in love with an investment idea and don't test their ideas rigorously. Make a point of searching out opposing views and engage with them. Many brokers, like CMC Markets, publish regular opinion pieces, and you should also read Barrons, Seeking Alpha and other online commentary. If you find data or arguments you had overlooked, do some more research. For instance if you had researched sub-prime mortgages in depth in 2006, you might have noticed negative trends that would have kept you clear of the market - before it crashed in 2007.
Monitor your performance. This is something many otherwise good investors don't do. It's easy to say "I'm doing all right," but if your investments rise 20% but the market has doubled, you've missed out - and you need to know that to do better in future. Make sure you know how you're performing and why - what were your big mistakes and your big successes. Analyse why you got things right or wrong and work out how to do better in future.
Back your own judgement. It's easy to go with the flow when everyone is telling you to buy the latest super stock or new emerging market. But if you've done your research and you really can't see a good reason to buy, make that judgement call. It could save you a lot of money.
Remember,too, that there are thousands of potential investments out there. If you check one out and something doesn't seem right, just move on to the next idea. When you find the good one, it'll pay for all the "wasted" research you did before.
