Thoughts on Using Investment Advice

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Recently, I was offered the opportunity to promote an online investing conference. This prompted me to reflect on and articulate my thoughts on using investment advice.

For most of my investing career, I've gotten ideas from outside sources and then sifted through them, choosing what made the most sense for me. The main sources I've tapped are portfolio managers, who manage a portion of my investments, and subscription newsletters, which offer investment insights and recommendations.

Here are my thoughts on things to consider when contemplating whether to pay for and use professional investment advice:

 

My philosophy should be aligned with the expert's advice

To apply this rule, I must have an investment philosophy. In its Investing Classroom: Portfolio 100 course, Morningstar gives direction on defining a philosophy and developing an investment policy statement.

Components of a philosophy can include my approach to portfolio design, risk and diversification, cost, and taxes. For example, I may favor recommendations that can be executed and managed at a low cost, or I may be willing to pay a certain amount for the potential to achieve higher growth. I may focus on tax-efficient investment vehicles or I may want to make investment decisions independent of tax consequences.

Use recommendations as an initial screen, not an easy solution

Just as I might screen a potential hire for a job opening, a contractor for a home improvement project, or a babysitter for my children, I'll want to establish criteria for considering and choosing an investment. Generally, I'll likely have minimum qualifications and ideal ones.

When interviewing candidates, I may find myself incorporating new information I hadn't considered previously or formulating a decision partly on instinct. Perhaps I hadn't thought of requiring a babysitter to have CPR training or, after a round of interviews, I realize that I prefer to hire someone who lives in my neighborhood. But this expanded realm of thinking shouldn't ignore my original criteria.

Screening tools should be specific and measurable, even if they include qualitative analysis (does the contractor answer my questions or talk to me patronizingly?). A polished presentation shouldn't lead me to compromise on key elements of my decision-making process.

To develop investment criteria, I may refer to the Ask Questions list published by the SEC (U.S. Securities & Exchange Commission). For example, I could ask “How will this investment make money? (Dividends? Interest? Capital gains?) Specifically, what must happen for this investment to increase in value? (For example, increase in interest rates, real estate values, or market share?)”

Similarly, I might screen recommendations based on a “yes” to the following questions:

  • Is this investment easily bought and sold on the open market?
  • Is the underlying investment profitable (that is, is the business in which I'm investing making money?)
  • Am I comfortable with the way the business makes money? (that is, does the business model make sense to me?; is the business philosophy aligned with my ideals?; do I see a long-term, competitive future in this business?)
  • Is the current price of this investment at or below its value?
  • Do I anticipate this investment delivering returns that are equal to or greater than a certain benchmark?
  • Am I comfortable with the risk associated with this investment?
  • Are the fees associated with this investment reasonable and within my ability to pay?

When I've had success with investment recommendations, it's been because I applied additional screening filters to the expert idea.

Consider how an investment recommendation fits within my portfolio

When considering a recommendation or piece of expert advice, I think about how such an investment fits with the specific needs in my portfolio. Just as I wouldn't hire a carpenter to install a new HVAC system, or the babysitter to repair my car, I wouldn't want to buy a growth stock meant to be a tiny portion of my holdings to represent the core (or the majority) of my portfolio.

Before making a decision about a specific recommendation, I like to think about what this investment should do for me. Here are the types of questions I might ask:

  • How much, if any, of my portfolio should be invested in this recommendation?
  • What will this investment do for me: Will it generate income, offer growth potential, reduce risk, increase my exposure to a certain asset class, etc?
  • What will happen to this investment in periods of inflation, economic slowdown, high interest rates, etc.?
  • How much time will this recommendation take to manage? For example, will this approach or selection involve frequent trades or complex tax planning?

An investment may not be able to do it all (offer growth and generate income, for example) but it should fill a specific role within my overall financial plan. In addition, I should have the resources required to manage its presence in my financial life.

When I've made a mistake with a recommendation, generally it's because I didn't apply stringent screening filters and didn't consider how an investment might fit within my portfolio.

While studying a Fidelity survey of millionaires for an article on this topic, I learned that many wealthy people pay for such services. But they don't wholly rely on them; instead, they glean ideas and insights, and apply them to their personal situations. I think that's a healthy approach: Listen, learn, test ideas, and make independent investment decisions that fit my philosophy, screening criteria, and portfolio needs.

Have you tapped experts for investment advice? What rules do you follow when making an investment decision?

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