Using Investment Advice, Part 3

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?

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David J. Merkel, CFA, FSA, is 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. Previously, he managed corporate bonds for Dwight Asset Management. At time of publication, neither Merkel nor his fund had any positions in the securities mentioned in this column, though positions may change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. While Merkel cannot provide investment advice or recommendations, he welcomes your feedback and invites you to send your comments to [e-mail].

Analyst Certification: All of the views expressed in the report accurately reflect the personal views of the research analyst about any and all of the subject securities or issuers. No part of the compensation of the research analyst named herein was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed by the research analyst in this report.

Merkel is employed by Hovde Capital Advisors LLC (the "firm"), a registered investment advisor with its principal office located in Washington, D.C. The Firm and/or its affiliates have or may have a long or short position or holding in the securities, options on securities, or other related investments of the issuers mentioned herein.