Due Diligence

Estimated reading time: 5 minutes(Last Updated On: September 2, 2021)

Due diligence is a step by step process to help protect your IRA from investment fraud and to determine if it is the right investment for your IRA. Investment is the application of money in order to gain profitable returns, as interest, income or appreciation in value. All investments have risk and there is a constant battle between risk and reward. The more you know about the investment the better you will be able to judge whether the risks are balanced by the reward and whether investment fraud could be possible. That is why at Quest Trust Company we recommend that you invest in things you know. We believe you should be more cautious when you are investing your IRA funds because they are intended for retirement. We had a client who invested all his retirement funds in a big investment that was guaranteed to payoff big, but his widow found that it was a Ponzi scheme and she was left with only social security for retirement.

The reason investment fraud succeeds is because people are lured into emotional decisions by the con artist without first completing their due diligence. Due diligence is what forces you to uncover the facts about the investment and make a rational decision. Con artists spend much time and energy preparing strategy and learning techniques designed to convince you to buy on faith without investigating. They study the characteristics of affinity groups to create a sense of trust and common bond. They have well-rehearsed answers to common questions.  They target small individual, non-accredited investors because individual investors rarely do their due diligence; whereas, institutions nearly always do. That makes small investors easier prey.

Investigators and prosecutors cannot protect you from investment fraud. Even with secured, regulated investments you should always assume that fraud is a possibility. The front-line of defense against investment fraud is an educated and skeptical investor. You must protect yourself and your IRA. That is why due diligence is necessary.

The Due Diligence process begins with broad general questions and narrows down to specific questions about the investment depending on the type.  At any point during the process you find that the investment has too great a risk for the amount of return or has a high probably of fraud, then you can stop the process and move on to another investment. Don’t commit to the investment until you have all the pertinent details.

 The first general question is does the investment offer make good business common sense? If it is too good to be true it usually is. Above market returns only make business sense if a competitive advantage exists that you can exploit but other potential competitors cannot.

Below are two questions to help you address the business common sense test for any investment: 

  • How exactly does this investment strategy create above market returns? What is the competitive advantage?

Ask yourself if the answer you are given is complete, thorough, and makes business sense. Is the answer is glib, laced with jargon and techno-babble, or is it simple and straightforward? Do you understand the competitive advantage well enough to explain exactly how it works to someone else? If you can’t explain it then you don’t understand it.

  • What are the barriers that will lock out competitors so that additional capital and supply doesn’t force returns down to market level?

There must be a legitimate business reason that returns will remain excessive. Again, does the answer pass the common sense test or does the explanation sound like something from the Top 10 Warning Signs of Investment Fraud?

1. It promises “guaranteed” returns;

2. It promises high returns for little or no risk;

3. It’s being pitched by a leader in your community or a fellow group member, such as ethnic, racial, religious, or other groups;

4. It involves a reverse merger stock or your money has to be sent overseas;

5. It involves “break-through” technology;

6. It’s tied to a current natural disaster;

7. It’s unregistered, or it’s being pitched by an unregistered adviser or salesperson;

8. It lacks documentation, such as prospectuses, offering statements, or financial reports;

9. It’s difficult to understand; and/or

10. The pitch comes with high-pressure sales tactics that push you to purchase immediately.

       Fully exploring these two questions should eliminate most investment fraud right from the beginning. In order for an investment to pay you above market rates of return it must have a competitive advantage and barriers to competition. If it doesn’t then it can’t pass the business common sense test for legitimately offering above market rates of return.

      Be wary of over friendly and charming promoters who respond to your questions with techno-babble terminology or disdain for the question.

       Serious questions are a symptom of a serious buyer and honest salespeople know it, welcome it, and respect it. They have nothing to hide so they will attempt to simplify their answers so you can understand the investment and make an informed decision.

      What you want is a professional sales environment where a rational, fully informed decision can be made. You want to ask your questions and get straightforward answers. Never allow trust, friendship or emotion to get in the way of that task. It’s your money and investing is serious business.

 When you don’t understand an investment it doesn’t mean you are dumb: it just means the investment doesn’t make sense. Never settle for anything less than a complete and detailed understanding that allows you to make a fully informed investment decision. Drill them until you get the answers you deserve.

The next general question: How can I lose Money? All investments have risk.

 To discover the risk of loss ask the promoter the following questions and don’t be surprised if you have to press hard to get a thorough answer:

        (1) What are all the conditions under which this investment will lose money?

(2) What is the worst market environment for this investment strategy?

(3) What assumptions or correlations must remain valid for profits to continue?

(4) What crazy, impossible to imagine situations would result in losses if they actually occurred no matter how remote the possibility of their occurrence?

     Until you uncover the risk inherent in the investment strategy then you don’t understand the deal. If the risk doesn’t appear, then the investment is probably not legitimate or you don’t understand it. Also be wary of guarantees. Guarantees are frequently marketing tactics designed to make you accept claims at face value, invoke trust, and make your decision easy so that you don’t look deeper into the issues.

 The next general question: What are the track records, backgrounds, and histories of the person and company soliciting the investment including information about officers, directors and other key personnel? Research and verify all information about the company and claims by the company. Review recent financial statements for the company and verify addresses.

 With these general questions answered and passed you are ready to investigate the particular investment and its appropriateness for an IRA depending on the type of investment:


4 thoughts on “Due Diligence

  1. Great article. I am already a client of Quest and I like to look at your seminar topics and read articles like this one when I am on your website.

  2. Nice! The first two paragraphs of this article should be copied and framed for the walls at Quest. So hard to hear about people loosing their entire IRA account. It’s not freely mentioned in the classes or speaker events. A smart person learns from their mistakes / a very wise person learns from the mistakes of others. Keep up the good work and continue to pound the table on due diligence! Maybe someone will listen.

  3. This really open my eyes as this is my first time to get involve in real estate investing with my money. I intent to learn as much as possible to prepare me to invest. Good articles.

    1. Hi Anita, I am a new real estate investor and have recently retired my w-2 and I am looking into rolling over my 401k from my w-2 into a soloIRA plan and was excited to see a fellow investor and wanted to follow up with you to see how your doing with yours. Any feedback will be helpful! Thank you and all the best to you and your future investments!

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