Your Funds: 5 questions to ask before buying a ‘radio stock’

Jerry in Falls Church, Va., was listening to a podcast the other day when he heard talk about an investment that sounded good enough to buy.

“I know why I want to add it to my portfolio,” he explained in an email, “but I wanted to ask you if there is any reason why I shouldn’t add it to my portfolio.”

Jerry was asking because I host the show he was listening to. One of my regular guests on “Money Life with Chuck Jaffe” is Tom Lydon, editor ETFTrends.com, who recently made the ProShares S&P 500 Bond fund his “ETF of the Week.”

The first corporate bond ETF focused solely on issuers from within the Standard & Poor’s 500 Index, SPXB – we’ll call the fund by its ticker symbol – is a new issue that opened about a month ago. There’s little doubt that the conversation with Lydon made the fund sound appealing, but most people would question the wisdom of buying anything you first heard about by radio, in print, during a podcast or on television.

Goodness knows, I have given investors the warning countless times that they need to be exceptionally diligent before acting on what I call “radio and tv stocks,” the things you hear about through the media. Yet there is no denying that what people most want to hear about is what they should buy.

For all of my cautions, I have no doubt that plenty of listeners hear guests say their magic words – something that flips their “buy” switch – and they are ready to pull the trigger.

Regardless of the investment – because Jerry just as easily could have wanted to buy the “Stock of the Week” from AAII Journal editor Charles Rotblut or any number of securities discussed in detail by the portfolio managers who visit – my answer would be the same, namely that no matter how good any investment sounds, there could be plenty of good reasons not to buy it.

The next time you hear about some “good investment” – whether the medium is the media or your barber or your financial adviser – adding a few questions to your basic due diligence will help you decide if generic advice can be a specific help to you.

Here is the ground you should cover:

1) Do I need this investment? Does it improve my portfolio?

Everything in your portfolio should be there for a reason. Adding investments that cover the same ground as what you already own is faux diversification. In Jerry’s case, for example, SPXB would have overlap to any domestic corporate bond fund, so he would have to decide if it was different enough to be worth including.

That broader outlook is important too, because adding a good investment that doesn’t truly upgrade your portfolio is simply adding work for you as the person running the portfolio. You want a good investment portfolio, and not a collection of “good” investments.

2) Am I willing to invest in it meaningfully?

Many investors have trouble committing to investments, so they invest small amounts in everything, without much real conviction. Again, this siphons off some of your brain space for an investment that – because you hold so little – can’t effectively help your portfolio if it turns out to be a good choice.

Have a minimum size for holdings in your portfolio. If you have $250,000 in assets, for example, your minimum size might be 1 or 2 percent of that; thus, if you aren’t willing to invest at least $2,500 (or $5,000 if you set a 2 percent minimum) into a security, it’s not worth the effort.

If you are putting meaningful money into something, it will encourage your disciplines; you will do your homework and make decisions based on more than what you heard somewhere.

3) Are there any tax consequences?

If you decide that a new investment would improve your portfolio, and you are using it to replace something you already own, make sure you calculate the taxes involved and think that the touted investment can quickly earn back whatever you owe Uncle Sam.

You may think you are changing horses in the middle of the race, but if getting off the first horse creates a tax headache, it will be as if the new horse has to do a penalty lap before it can really get to work for you.

4) What are the drawbacks?

Most of the time when investments are being pitched and touted, the warts are glossed over. In Jerry’s case, new funds with small asset bases often fail to reach critical mass, and then die off. That’s a hassle. Likewise, with the fund being so new, it’s impossible to use certain metrics until more time has passed; Tom Lydon favors a 200-day moving average, for example, but noted that it picking SPXB that it will be months before this fund has one.

5) What do I know about the person giving me the information, and how will I find out if they change their mind?

As the stock market peaked right before the Internet bubble burst in 2000, Jim Cramer was the featured speaker at an event sponsored by the Miami Herald. Asked for his favorite stocks, he threw out four names; when the market started collapsing the following week, those stocks were down and Cramer got out.

The audience that heard him at the event, however, didn’t necessarily get the message. A year later, several audience members were lamenting their misfortune.

Picks – especially those made through the media – tend to be fleeting. “10 Stocks to Buy Now” could be a valid headline on an investing magazine every single month of the year, but that hardly means someone should buy each list and hold it forever.

If an expert is talking about buying something, but you won’t necessarily be around to hear them say when to sell it, discount their advice and don’t buy anything until you are doing it based on your due diligence and planning instead of their recommendation.

This article provided by NewsEdge.