This week, Federal investigators arrested former money manager Martin Shkreli for securities fraud. Shkreli, who gained infamy earlier this year when his company, Turing Pharmaceuticals, bought a decades old drug used to treat parasitic infection in order to hike its price by 5,000%, will face charges that he illegally bilked millions of dollars from his former company, Retrophin, (NASDAQ:RTRX) in order to placate investors who had lost millions of dollars investing in his hedge fund.
Shkreli's story serves as an important reminder to investors that they need to do plenty of due diligence before handing over their hard-earned cash to someone else to manage. With that in mind, here are three things investors ought to consider before hiring a money manager.
No. 1: Bigger is better
According to Retrophin's lawsuit, Shkreli's hedge fund was virtually bankrupted by a $7 million bad investment and those losses led to a series of payments and illegal stock grants while he was at Retrophin that resulted in his ouster as CEO, a $65 million lawsuit against him in August, and his arrest on Dec. 17.
Although it may be tempting to grubstake a young manager that's had some success in the past, doing so may expose an investor to a fund that lacks the ability to appropriately diversify its risk and manage its way through the market's inevitable drops.
Therefore, when considering an investment manager, consider sticking with big, tried-and-true fund managers that employ a diversified and steady-eddy approach. Their larger size could mean that they've got the staying power to be around for the long-haul and a less risky approach could limit the chance that an investor's nest-egg is wiped out if one idea goes bad.
No. 2: Be skeptical of unrealistic claims
Even as Shkreli was losing investor's money, he was reporting significant market returns to them. In 2010, when he was down 18%, for example, Bloomberg reports he was telling investors he was up 35.8%.
It's scary to think that someone could so dramatically inflate their performance, but Shkreli isn't the only former high-flying fund manager to lie about his returns. Bernie Madoff, the billionaire hedge fund manager that fell into disgrace in 2008, misled investors about his returns for more than a decade. In 2008, for example, Madoff claimed his fund was up 5.6% when the S&P 500 had fallen 38%.
That kind of too-good-to-be-true outperformance should set off warning bells. After all, markets go up and down and most managers, despite their best efforts, will similarly go through periods of poor performance. If a money manager claims a certain rate of return that doesn't pass the sniff test, ask for more insight into their investment process, and if the manager's answers don't ring true, look for someone else to manage your money.
No. 3 Educate yourself about investing
Investors are best served when they actively engage with the people who are managing their money. Visiting with a money manager regularly, rather than leaving statements unopened in an inbox, may make it easier to spot trouble early on.
Importantly, spending time online learning about investments, money, and financial planning can make those regular sit-downs with a financial advisor even more productive because it gives an investor an opportunity to explore current investment strategies -- and discuss important life changes that could impact a financial advisors' recommendations -- in greater depth.
Tying it together
The best frauds are hard to spot and there's no guarantee that an investor won't fall victim to one, but focusing on large and established firms with a solid reputation, being suspicious of unrealistic returns, and taking an active role in educating yourself about how your money is being invested may reduce the risk.
Todd Campbell has no position in any stocks mentioned. Todd owns E.B. Capital Markets, LLC. E.B. Capital's clients may have positions in the companies mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.