The Importance of Being an Informed Investor

Today, there is no shortage of information about investing. But having a wealth of information at your fingertips does not necessarily make you an informed investor.

Becoming an informed investor means taking time to examine each investment opportunity before you invest. Successful investors review the information they're given, ask questions, and make sure they understand what they're buying. Here's a checklist of questions to help you make informed investment decisions.

Q. Do I understand the investment?

Securities laws protect investors by requiring companies to give you the information you need to make decisions. Make sure you get the written documents, such as a prospectus or offering circular, before you buy. It's important to review the information on your own. Don't rely on investment advice from family and friends. They can't evaluate the investment from your perspective.

Ask questions about anything that you don't understand. Don't be intimidated by jargon - after all, it's your money. If you're buying an investment directly, ask a professional at that organization; if you're buying through a financial professional, ask that person. No matter how basic you may think your questions are, these professionals would rather answer them before you invest so that you're better prepared for what may happen after you invest. Do not sign anything that you don't understand.

Q. Does the investment match my goals?

Whether you are investing for long-term growth, investment income, or other reasons, an investment should match your own financial goals. Ask yourself how this investment could make money for you and over what period of time. How does its past performance compare with that of other investments with the same objective? Would that performance be adequate to meet your goals? (But keep in mind past performance cannot predict future results.) Why is this investment appropriate for the specific goal you've set? For more information about setting goals, please see Investing for Success: The Importance of a Long-Term Perspective.

A Checklist of Questions for Informed Investors

Q. Do I understand the risks?

Every investment involves some element of risk and different types of investments have different types of risks. You should know what these risks are and how they match your own risk tolerance profile. Are you prepared to accept the risks associated with this investment? If you can't afford the risk, don't take it.

But don't opt for the most conservative investment without considering the risk of inflation. (If the rate of inflation rises faster than the earnings on your investment, you will be left with less real purchasing power than when you bought the investment.) For more information about risk, please see Investing for Success: Understanding the Risk & Reward Relationship.

Q. Do I understand the costs?

The fees you pay to buy, maintain, and sell your investment can significantly affect the returns you get. Common types of investment fees include transaction fees - which you pay directly - and management fees - which are deducted before earnings are distributed to you.

Commissions and spreads are examples of transaction fees. You can be charged a sales commission when you buy or sell stocks, bonds, or some types of mutual funds from financial professionals. Some financial professionals, rather than charging commissions, charge fees based on an hourly rate or a percentage of assets. The spread is the difference between what you pay for a stock or bond and what the security dealer pays for it. Management fees represent the ongoing costs of managing a mutual fund; these expenses are deducted from the fund's earnings.

If you're working with a financial professional, make sure you understand how and when that person is paid. Do you have any payment options? What services do you get in exchange for the fees? If you're investing in a mutual fund, read the fee table at the front of the prospectus. A higher-cost investment may make more money for you, even after accounting for the costs you pay, than a lower-cost alternative. Of course, the opposite may also be true.

Q. How liquid is this investment?

How easily could you sell this investment if you need your money unexpectedly? Would there be any penalty or charge for doing so? What would be involved in selling it suddenly?

Q. Is the investment legitimate?

Is this investment registered with the U.S. Securities and Exchange Commission? How long has the company been in business? How experienced is its management? If you are working with a financial professional, how experienced is this person? If you have any doubts about an investment's legitimacy, check with the appropriate government agency and consult other trusted information sources. When presented with investment opportunities that seem to offer much higher returns than other comparable investments, remember: if it seems too good to be true, it probably isn't true.

Q. Are my investments diversified?

Investing all your money in a single, undiversified investment is risky. If the investment fails, you stand to lose everything. Wise investors allocate, putting their money into a variety of investments or into one or more diversified mutual funds to assemble a portfolio that spreads and balances their investment risk. When considering a new investment, ask how it fits with other investments you're considering or that you've already made. You may find you need to redistribute some of your money to bring your investment mix back into line with your original diversification plan. For more information, please see Investing for Success: The Benefits of Diversification.