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What Is Investment Due Diligence?

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  • Written By: Geri Terzo
  • Edited By: A. Joseph
  • Last Modified Date: 12 December 2014
  • Copyright Protected:
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    Conjecture Corporation
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Before a person or organization invests any amount of money in something, proper investment due diligence is vital. Whether it's stocks, bonds, real estate assets or any other type of financial commitment, the more research and preparation that is done on that investment, the better. Sometimes there is a structured investment due diligence checklist to follow, but other times, it will require some creativity coupled with common sense for any unnecessary surprises to be avoided, especially when it comes to money.

When an investor decides to place money with an investment firm, that investor can expect that a respectable amount of due diligence will be done by that firm before any investments are made. Money managers are accountable for the money that they invest on behalf of clients. Still, investors should do their own investment due diligence as well. This means vetting the investment firm before giving it any money. The investor should read a prospectus, which is a regulatory filing that outlines the history of the firm, and should look for the profit history, risk profile and any severe changes to key management that might be a red flag for instability at this firm.

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For an investor who is placing money with a professional manager, an informal investment due diligence checklist is a good way to begin. The investor should make sure that an outside accounting firm is engaged by the plan to perform auditing services so there is less of a chance for fraud. A third-party accountant adds accountability to the investment management firm. Also, in the investment firm's prospectus, the investor should review the performance history of a fund to look for consistency. Any aberrations will require further questioning by the investor.

The investor also should make sure that the fund has stayed true to the investment style outlined in the prospectus. Sometimes a fund manager will change the style after receiving investment money, and the investor cannot do anything about it except withdraw the funds if the new style is not the direction in which he or she wants to go. Investors can avoid having to exit and re-enter new funds by doing proper investment due diligence and recognizing stability in an investment firm.

When individual stocks or bonds are involved, track record is key once again. If the investment has been a steady performer over time, this is a good sign. When there is an extreme change in investment performance in either direction, one can get an explanation by calling the investor relations department at a firm. Also, investing in companies that have proven profitability adds stability to any investment decision. If investing in real estate, one can find out what the growth projections and development expectations are for an area, because this can influence the resale value of a property in the future.

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