Due diligence is the investigation and research that an investor should conduct prior to making an investment to determine whether that investment is right for them. This is true for any kind of investment — from stocks to real estate to businesses.
It’s technically a legal obligation for some investments but I would argue that it’s essential for any investment and, in fact, for any kind of agreement or acquisition at all, whether it’s your home or car, or even whether you’re thinking about entering into a relationship with someone. (In a way, it’s all an investment — your car is an investment of money into your ability to get around; your new relationship is an investment of time and energy into a friendship or romance).
Ultimately, due diligence should answer the question: “Is this investment right for me at this moment?”
Good due diligence should first seek to understand that investment (or whatever) as thoroughly as possible. Then, it should consider what the investment means to you and your own goals and timeline.
HOW TO UNDERSTAND THE INVESTMENT
To understand the investment, you need to explore it thoroughly. If it’s a stock, you need to study the stock itself, the industry, and market trends (and so much more. If it’s a real estate investment, you need to study the marketplace, the tenants and property management company, and the costs of maintaining a home in that area (and so much more). Even if it’s a potential romantic partner, you need to know what they’re hoping for a relationship, how they enjoy spending their time, whether the attraction is mutual, etc.
HOW TO CONSIDER WHAT THIS INVESTMENT MEANS TO YOU
An investment, by its very nature, requires you to trade something of value for the potential of a return. That thing of value could be money, time, effort, or many other things. So it’s important that you know what is required of you (and whether you have that to give) and what you can expect. And perhaps most importantly, you need to decide whether the expected return is what you want. Many investors buy into something without really thinking about whether it’s right for them at this moment in time; they end up putting up too much value and receiving returns that they are disappointed with.
DO YOUR DUE DILIGENCE — ALWAYS
Regardless of your investment, it is impossible to perform too much due diligence. However, there comes a point when, practically speaking, you’ve done enough due diligence to move forward. I don’t think people have a problem with the idea of due diligence; rather, I think people do too little due diligence.
(Side note: As a real estate investor, I hear a lot of people say that they’re doing their due diligence but what they’re really doing is being stalled by fear and they are allowing that fear to catch them up into a loop of “analysis paralysis”. Strangely, I only see this in real estate and business investments — never in the stock market.)
Do not leave your due diligence in someone else’s hands. Sure, your financial advisor might help you perform some of your due diligence but don’t think of them as a replacement for due diligence! Do it yourself. Be thorough. Don’t rush.
Check out some of my other writing on due diligence including:
- How to do due diligence on a junior resource company
- How to do your own due diligence (regardless of the investment)
- My 17 rules for investing