Five Basic Due Diligence Steps Every Investor Should Consider


Due diligence analyzes and mitigates any risk that’s associated with an investment decision. A thorough examination of the financial records of the investee will turn up any possible performance issues. Although the process is voluntary, it makes smart financial sense to perform due diligence before investing.

Before you make an investment decision, you need to answer the following five questions: 


  • What is the investment strategy and do you understand it?
  • How has the investment done over multiple market cycles?
  • Who has custody of the assets?
  • Who generates the statements?
  • Who is the auditor?
  1. What is the investment strategy and do you understand it?


An investment strategy is a plan designed to help investors achieve their financial and investment goals. Investment strategies are specific but in many cases, individual circumstances play as big a role as the actual strategy  Individual circumstances usually depend on four major factors:

  • age
  • available capital
  • risk tolerance
  • goals

In other words, as you devise your own investment strategy, you will want to keep some key ideas in mind and ask yourself some specific questions. For example: Do you understand the risks involved with the particular stock or company? How much are you willing to invest? How much are you willing to lose? What are your goals for this investment?


  1. How has the investment performed over multiple market cycles?


Although the recent price performance of a strategy doesn’t guarantee future price movements, it’s beneficial to note the short-term and long-term performance.  It’s not uncommon for investment managers to have a hot hand only to lag off in a different market cycle. How have they done over 1, 3, 5, or 10 years or longer is equally important. 



  1. Who has custody of the assets?


A financial institution usually holds assets to prevent them from being stolen or lost in both electronic or physical forms. Investment advisors are required to arrange for an asset custodian for their clients. Since they’re responsible for the safety of assets often worth more than hundreds of millions of dollars, these custodians are almost always large, reputable firms.


Knowing where your money is physically kept is critical.  If you’re not clear who will maintain custody of your assets, ask your financial advisor to provide you with the custodian’s contact information and some financial information.


  1. Who generates the statements?


Financial statements encompass numerous essential pieces of information about a business. This information includes revenue, expenses, profitability, and debt. Investors need this information to make educated decisions about their investments. The U.S. Securities and Exchange Commission (SEC) requires companies to report their financial statements on a quarterly and annual basis.


If you do not receive a statement directly from a qualified custodian, then you need to contact your adviser or custodian to find out why. You’re entitled to this information as an investor.


  1. Who is the auditor?


Are you performing the audit yourself? Did you hire someone? Do you trust that person? Do they have a vested interest in the targeted company or are they completely unbiased?

Hiring an objective third party who has the know-how and experience to perform an audit saves you the trouble of covering every single base. You need to be armed with as much detailed information as you can get before investing your hard-earned money. Thorough due diligence reduces your chances of making the wrong investment decision.  Most auditors in the financial services industry are held to industry standards such a PCAOB. The Public Company Accounting Oversight Board oversees the audits of public companies and SEC-registered brokers and dealers.