The 5 Things That Will Minimize Your Investment Risk

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by Robert Kantor


Conducting exhaustive due diligence is the second of two unwavering rules for investing. My most recent post addressed how to identify the most experienced and successful experts and instructors with whom to invest. This post will explore my five rules for conducting systematic due diligence to reduce investment risk.

Investment and financial professionals use the term due diligence to refer to an investigation or audit of a potential investment to confirm all facts, such as reviewing all financial records, plus anything else deemed material.

Due diligence involves thoroughly researching the people who will be managing the enterprise, and the project in which the investment capital will be put to work. Several techniques exist that can make the due diligence process quick and efficient. 

Begin with identifying the most honest, competent, and experienced managers and sponsors committed to a well-conceived project that holds the prospect of adequate financial rewards. Once you understand what questions to ask and whom to consult, you will be able to efficiently and effectively collect and interpret the data required to make an informed investment decision.

Due diligence can be reduced to five rules:

  1. Evaluate the integrity, expertise, and managerial capability of the project’s principals. As the title of Claude Rosenberg’s book on choosing investment managers puts it, Invest with the Best.
  2. If the principals pass muster, the next step is to thoroughly analyze the economics and risk-reward ratio of the project. Scanning the offering materials is insufficient. Collect information that will enable you to independently determine the possible rewards and potential risks of the investment concept. You need to know if the data is accurate if the financial projections and assumptions are realistic.For example, verify the legal and tax assumptions printed in the offering materials for a limited partnership. Investigate the fund manager’s investment philosophy and record under similar circumstances for a mutual fund.
  3. Whenever you are examining an investment outside your own area of expertise, consult with independent experts. Do not solely trust the information provided to you by those who stand to profit by your decisions to invest. The person must have a minimum of five years of successful experience in his or her field to qualify as an expert in this sense.
  4. Once you have reviewed all the information and expert opinions, trust your own judgment and instincts. It’s your money, you make the decision.
  5. After you have committed your funds, conduct ongoing due diligence to protect your investment. 

Most businesses perform such basic research and analysis at every turn of the economic clock. Bankers investigate the creditworthiness of loan applicants, brokerage firms analyze stocks before adding them to their buy lists, and financial planners research limited partnerships before recommending them to clients.

You’ve probably done similar research in your own work, such as checking the background and skills of a prospective employee or speaking with a vendor’s clients to judge their satisfaction with the vendor’s products and services. A brokerage firm’s research department is highly capable of conducting quality due diligence.

Accurate, detailed information is an investor’s most precious asset and performing due diligence will better position you to consistently earn healthy profits while putting yourself at minimal financial risk.

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