The following was published on 3/29/2004:
Time horizon usually correlates with return size.
It’s good to have signposts as the investment plays out.
Free advice is seldom cheap.
In analyzing any advice, investors have to consider the adviser, personal character issues and the nature of the investment proposed.
In Part 1 of this three-part column, I focused on the adviser. In Part 2, I looked at issues centering on your personal character.
In Part 3 today, the emphasis shifts to the investment itself.
Many Things to Consider
Good investment recommendations give some idea of how much to play for and the likelihood of getting there, even if the appraisal of likelihood is subjective and squishy. Are we looking to scalp a dime, a buck, 10%, 100%, or are we looking to score the elusive ten-bagger?
Most often, the time horizon of an investment corresponds to the amount targeted to be earned. Under normal circumstances, gains are made a little at a time. Bigger gains ordinarily take more time. How long will it take to earn what is expected from the proposed investment?
What risks exist in realizing the value inherent in the investment? What could go wrong? Nothing is certain in investing, so beware of advice that tries to sell hard on the idea of safety. Appeals to safety, particularly with investments that are touted to earn an above-average return, are often dangerous. The price adjustments with supposedly safe investments that disappoint are sometimes severe. I experienced this firsthand with corporate bonds: The most dangerous bond was the one everyone knew was secure, and then accounting irregularities popped up. The price would drop 10% to 20%, and liquidity would drop to nil.
If the investment is going properly, what signposts will you see to validate that the investment idea is on track? Aside from price action, what will yield clues that the investment thesis is wrong or right? What should earnings look like? When is that new product going to be introduced?
What factors in the macroeconomic environment does the investment rely on? If inflation rises, what will happen? Does this investment resist recessions well? If the market falls, will this investment fall harder?
Finally, how well does this investment fit into your portfolio? Does it reduce risk for you, or increase it? Too much of a good thing can be wonderful, but the more concentrated your bets become, the closer you must watch your positions. The higher the degree of concentration in a portfolio, the higher the amount of expertise relative to the market the portfolio manager must possess.
No one will give you all of this in advice, but these are things to keep in mind to aid in the evaluation of advice that comes your way. In general, a conservative and skeptical posture will serve you best. Keep a tight hand on your wallet, and remember that those who stay in the game the longest often do the best.
Finally, you can remember Ferengi Rule of Acquisition No. 59: “Free advice is seldom cheap.”