Should You Follow Investment Advice? Part II

Should You Follow Investment Advice? Part II

Part two is understanding the advice.  A large part of the problem is that many aspects of the advice are unsaid.  For example, with a “buy” recommendation:

  • What time horizon does this recommendation require?
  • How likely is it that this investment will succeed?
  • What risk factors could cause the investment to fail?
  • How will this advice get updated?
  • Have prior investors benefited from this advice?
  • What is the benchmark for the advice?

Time horizon is important, even if it were handled approximately, e.g, “six months to two years.”  Should you buy for the earnings release and sell thereafter, or is this a company going through a multi-year shift?

The likelihood of success is subjective, but still important.  It helps if analysts/touts would clarify how certain they are of success, st least in vague terms.

Listing the risk factors is important.  Analysts do less of this than do companies in their prospectuses/10Ks.  These are important, and it would be valuable for analysts to see if there are any risk factors not listed, or emphasize the importance of key risk factors.

Knowing how frequently the advice will be updated aids the investors — it helps them understand how much help they will get, or whether after the recommendation, they are on their own.

It helps to know whether the adviser has any real talent or not.  Does he just opine, or is his own money on the line?  Has he succeeded in the past?

Finally, the benchmark is of utmost importance.  Buy! Why, what will it do better than?  Is it a relatively good stock?  Is it a relatively good stock in its industry?  Is it a relatively good bond?  Is it just going to do better than cash?  Y0u need to understand the comparison that the analyst is making in order to say the stock is a buy.

More in Part III

By: Alephblog:



About the Author

David Merkel
David J. Merkel, CFA, FSA — 2010-present, I am working on setting up my own equity asset management shop, tentatively called Aleph Investments. It is possible that I might do a joint venture with someone else if we can do more together than separately. From 2008-2010, I was the Chief Economist and Director of Research of Finacorp Securities. I did a many things for Finacorp, mainly research and analysis on a wide variety of fixed income and equity securities, and trading strategies. Until 2007, I was a senior investment analyst at Hovde Capital, responsible for analysis and valuation of investment opportunities for the FIP funds, particularly of companies in the insurance industry. I also managed the internal profit sharing and charitable endowment monies of the firm. From 2003-2007, I was a leading commentator at the investment website RealMoney.com. Back in 2003, after several years of correspondence, James Cramer invited me to write for the site, and I wrote for RealMoney on equity and bond portfolio management, macroeconomics, derivatives, quantitative strategies, insurance issues, corporate governance, etc. My specialty is looking at the interlinkages in the markets in order to understand individual markets better. I no longer contribute to RealMoney; I scaled it back because my work duties have gotten larger, and I began this blog to develop a distinct voice with a wider distribution. After three-plus year of operation, I believe I have achieved that. Prior to joining Hovde in 2003, I managed corporate bonds for Dwight Asset Management. In 1998, I joined the Mount Washington Investment Group as the Mortgage Bond and Asset Liability manager after working with Provident Mutual, AIG and Pacific Standard Life. My background as a life actuary has given me a different perspective on investing. How do you earn money without taking undue risk? How do you convey ideas about investing while showing a proper level of uncertainty on the likelihood of success? How do the various markets fit together, telling us us a broader story than any single piece? These are the themes that I will deal with in this blog. I hold bachelor’s and master’s degrees from Johns Hopkins University. In my spare time, I take care of our eight children with my wonderful wife Ruth.