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Three Investing Lessons from Bernie Madoff
by Mark Skousen, Contributing Editor
Tuesday, July 7, 2009: Issue #1034
Last week I caused a bit of a controversy on Fox News when I suggested that Bernie Madoff might do more good than harm in the long run – there are some good investing lessons for everyone to note.
Don’t get me wrong. Madoff himself is a despicable person. Over a twenty-year period, he created the world’s biggest Ponzi scheme worth an estimated $65 billion. Hundreds of individuals, retirees, and charities were hurt or destroyed by Madoff’s deception.
He deserved to get the maximum penalty (150 years).
Nevertheless, I look at all the positive side effects of the Madoff scandal. Here are the three most valuable lessons we can learn from the biggest crime on Wall Street in a hundred years.
Investigate before you invest
Millions have now learned a powerful investing lesson. Don’t blindly turn your hard-earned funds over to a money manager just because he promises great returns year in and year out. Be a skeptic about money managers who insist they can beat the market all the time. Make sure the manager has an independent and reliable auditor. Check the monthly statements to make sure there’s no funny business going on.
“Due diligence” finally means something again when it comes to investing.
A corollary is: Manage your own money as much as possible. Use a discount broker and select your own stocks to buy and sell. Get educated by reading books, attending seminars, subscribing to independent newsletters, and asking a lot of questions.
Take responsibility for your actions; don’t blame others for your mistakes.
If you are still uncomfortable managing your own funds, consider investing in publicly traded mutual funds with good track records that you can value daily in the newspaper or online.
Diversify, Diversify, Diversify
I really have little sympathy with individuals or charities that were wiped out by Madoff’s shenanigans. Only the greedy or stupid would invest their entire fortune or foundation’s whole endowment in a single investment.
It’s time to return to fundamentals, specifically, the “prudent man” rule that used to carry some weight on Wall Street and the New York media.
Always diversify so that no single investment can destroy your financial independence.
There is a great deal of virtue in the old proverb, “Don’t put all your eggs in one basket.” From time to time, you hear some guru suggest a modern alternative: “Put all your eggs in one basket -and watch that basket!”
In most cases, it’s a recipe for disaster.
Sure, most entrepreneurs have made it big by concentrating in one particular business, and when they get rich, the wise ones always diversify their surplus wealth – stocks, bonds, real estate, gold, and collectibles. To invest all their wealth with one money manager or in one brokerage account, that is pure foolishness.
Don’t depend on the government to protect you
Another investing lesson that many seem to blindly ignore is that you’re on your own.
Government lawyers at the Securities and Exchange Commission (SEC) were hopelessly outwitted by Madoff’s firm. Private financial investigator Harry Markopolos warned the SEC three times about Madoff’s fraudulent activities, but Madoff got a clean bill of health from SEC investigators.
Why?
Because the SEC has a penchant to go after the little guys, such as brokers promoting penny stocks, who are usually willing to settle with a small fine, even when they are innocent. SEC agents are judged primarily by “quantitative metrics” – the number of actions it brings and cases it settles.
Last month The New York Times highlighted the incredible story of a small-time California stockbroker who was investigated by the SEC for promoting a small cap stock.
The broker refused to settle because he knew he had acted ethically within the rules, and didn’t want his good name destroyed with a consent decree. Even though he was repeatedly exonerated by the courts, he was left a bitter 72-year old man with $1 million in debt defending himself. “They chose me instead of Bernie Madoff,” he said, and it cost him dearly. (See the June 27, New York Times cover story, “Chasing Small Fry, SEC Let Madoff Get Away.”
On a broader more philosophical basis, the existence of the SEC creates a false sense of security, giving the illusion that somehow the public is protected by the government from frauds, deception and scandal. Now we know better.
Investors must live by the rule, “Caveat emptor.” Let the buyer beware.
Good investing, AEIOU,
Mark
Today’s Investment U Crib Sheet
No one will ever take as much interest in your financial well-being as you do. It’s the reason why you should always know what you are investing in and why.
And it’s also the explanation why we continually recommend that readers do their own research. What’s right for your neighbor, might be completely wrong for you. Check any “hot tip” or stock suggestion out first, do you own research, and ultimately make you own decision on whether a company or security is a buy.
For example, last week we introduced readers to put option investing and an income alternative for GE. Both investments are great ways to add income to your portfolio, but that doesn’t mean they are right for everyone.
In addition, diversification and asset allocation are key principles behind Investment U’s approach because they spread your risk while giving you maximum gains. It’s funny how seemingly smart people – like many of Madoff’s investors – forget these simple rules.
These rules could have saved them billions.
A little investment education goes a long way.
And if you’re looking on getting caught up in yours, take a look at our Investment U archives. They contain all of our articles going back to 2002 – it’s an invaluable resource for investors to understand the ins and outs of investing. Also, stay tuned for some of the improvements coming down the pipe that include an enhanced education center.
- Lessons for Apple in Mays, Madoff
- Financial Fraud: 3 Easy Steps to Avoid “Bad” Investments
- After the Madoff-Ponzi, The Lesson’s Clear
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15 Responses to “Three Investing Lessons from Bernie Madoff”
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July 7th, 2009 at 11:05 am
Since the time of the 401k retirement investment plan started, millions of workers have invested their money into the plan along with their employer contributions. Most all of that money was invested in company stocks. It seems that the only money created on stocks is the dividends or profit that a company makes and divides among it’s stock holders. A divedend of 6% to 8% is considered a good return,but when you subtract the inflation loss of at least 4% (which will soon accelerate) per year and subtract the tax on the profits, there is very little profit and certainly not much left for retirement income. How can the increasing number of retirees live off of the taxed dividends, which are next to nothing, expecially with company profits declining? Also, many companys are discontinuing the 401k’s that feed the system. If retirees get desperate for income and start selling their stocks, won’t this drive stock values down, thus amplifying the problem? Isn’t this like the old “chain letter” scheme where those that get in first win, but the vast majority that get in later loose their money or like the Madoff Ponzi scheme? Thanks
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July 7th, 2009 at 12:03 pm
You say: Be your own investor
Have you any idea how many of us with high-fee managed accounts have never seen a share, bond or any commecial paper? Who keeps them? who informs you about dividends? How are they paid? Who tells your about stock splits and so on? I’ve never seen answers to this in any manual on investing.
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July 7th, 2009 at 1:26 pm
I suspect that most of Madoff’s investors couldn’t believe the returns…thus forgetting the old addage:
If it sounds too good to be true, it probably is.
Madoff will be forgotten by most investors in a time so short that it will be astounding. The “regulators” won’t even be able to find the book where the story is written, and it will happen all over again.
If the “due diligence” is not done…there will be a slick thief who will be happy to take advantage.
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July 7th, 2009 at 1:27 pm
I have all my money in Charles Schwab, Inc. brokerage accounts.
Does that mean I should spread it out among 25 broker, at 4% per broker?
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July 7th, 2009 at 1:33 pm
In business school, whenever we studied cases, there were usually lessons to be learned from the mistakes made. This article re-affirms that wise approach. However, you presented one factoid that deserves a clarification. The supposedly modern quote, “Put all your eggs in one basket -and watch that basket!” is actually by Mark Twain from Puddinhead Wilson’s Almanac (1894). Other zingers from the same publication include, “First God made idiots. This was for practice. Then he made school boards.” Enjoy!
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July 7th, 2009 at 3:21 pm
what does ” AEIOU ” MEAN.
THANK YOU
RON S
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July 7th, 2009 at 3:41 pm
The people who invested with Madoff were not greedy and are deserving of pity. There but for the grace of G’d go I. Madoff’s fund showed relatively modest but consistent returns, something particularly appealing to retirees. Madoff also had enormous credibility as a former head of the Nasdaq exchange. His scam would have continued to expand had not the financial markets collapsed and everyone demanded their money. You are quite right in saying that the Madoff investors who had all their savings invested in one place made a huge mistake. However, in many cases funds were channeled to Madoff through intermediaries, so many investors did not even know they were investing with Madoff.
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July 7th, 2009 at 3:47 pm
It seems to be an American penchant to go after the small fry and persecute them to death even when innocent. Why? I have no idea, perhaps it is due to the fact that bureaucratic people with huge egos like to stomp on people with small or normal sized ones. The big bad frys have huge egos and defense budgets themselves and are therefore untouchable. It seems like basic human psychology here OR Am I missing something here?
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July 7th, 2009 at 6:59 pm
If you really want to use the ’skills’ of Madoff you might consider recommending him to a govt position say at the SEC since he managed to pull the wool over their eyes for years and has not only destroyed peoples lives by all the other Madoff’s in the world
Of course the real culprits are the FED and US govt who have been running the biggest ponzi scheme ever invented ’social security’ so nothing that Madoff did is any different from what the FED is doing today except they are on the ‘legal’ side of the ledger. Just think if the current crises had never progressed to this stage Madoff would still be happily in business since he managed to PAY all of his ‘private security’ investors over 2 decades at a far higher return than what DSS are going to pay the 90 million boomer’s expecting a monthly check so PLEASE do not waste Bernie’s valuable experience and quickly ‘force hire’ him into any nationalized govt agency that pretends to redistribute money in an ethical/legal manner. The state of Calif could really use Bernie today as my IOU’s are not accepted by Alpha Beta Safeway or my landlord!
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July 7th, 2009 at 7:45 pm
Yes, every bitter experience leave teachings. I agree with you: markets will not be the same. We have learned to be on the safe side. But, is there anything left untouched?
Gold: The brokers get the big share!
Stocks: The brokers will never loose.
Bonds: You are loosing since the begining.
Real state: It will recover. It will be costlier to build.
Land: It will never be replaced. After the sixth day the Lord got tired. He rested on the seventh. No more land will be made.
Energy: That will be the future problem. there will not be enough. Buy it now: Oil, electrical power, etc.
I am starting to undersatand future!
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July 7th, 2009 at 8:09 pm
Your comment about having all your wealth in only a single brokerage account being foolish has me concerned. Are funds in my Vanguard account at risk, since I make all purchasing decisions?
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July 8th, 2009 at 7:33 am
Finally, someone who has told the truth about investing. After all the noise about Madoff, this is the first article I’ve seen that gives the basic advice needed for investing. Study, learn, check, use diversity and do it yourself. No one cares about your money more than you do.
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July 8th, 2009 at 1:17 pm
“There is a great deal of virtue in the old proverb, “Don’t put all your eggs in one basket.” From time to time, you hear some guru suggest a modern alternative: “Put all your eggs in one basket –and watch that basket!” ”
We have our investments at a major brokerage firm (affiliated with a large worldwide bank) and at a discount broker. I’m considering moving everything to the discount broker; my wife, however, is wondering if that amounts to putting “all our eggs in one basket.” I don’t believe so, since I have a significant number of investments (including many of the OC recommendations), and all of them are protected with stop loss orders.
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July 8th, 2009 at 10:24 pm
i am curious as to who is going to be able to champion the small- time California Stockbroker cause against the SEC. He obviously knows what integrity is all about. His debt together with loss of earnings must be met fully by the bullying of the SEC. The bigger question in my mind is the fact that the SEC is going to get away with this type of behaviour?
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July 13th, 2009 at 3:26 pm
Good Article on Madoff but BEWARE. I just heard of a small town broker who is entertaining his wealthier prospective clients at his vacation home with his family, waiting on them hand and foot. It may be hear-say or perhaps he has taken a Lesson from Mr. M. Is this method of prospecting legal or am I out of touch? Like I said may be hear-say.
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