Madoff with the Money

I’ve been following the Madoff money scandal with interest, but with limited surprise.  The only real surprise for me is the scale: $50 billion is big.  I am much less surprised that the regulators missed it.  For example, they missed Enron too.    It is also not surprising that big money investors were taken in.  The “keeping up with the Jones” competition is also a real phenomenon some members of the super rich.

History is replete with examples of wealthy individual who succumb to financial scams.   Look at John Law in 1700s France, for example.  He was an adroit visionary and scammer.  Check out Ponzi himself whose name is now synonymous with such cons.  It is with some satisfaction that I wrote about him and the dangers of unwary trust in this  August schemes and scams blog.  Another, less corrupt, but still costly debacle  that snagged experienced and wealth investors and companies was that of  Long Term Capital Management.

What I feel compelled to mention is a simple and wise maxim:  Diversify!  No matter how good an investment is (or seems to be) don’t risk putting your eggs in one basket.  Not one company’s stock, not one management company.  Secondly, it is simply unwise to invest a massive percentage of one’s portfolio in something so opaque as a hedge fund.

Let me clarify somewhat.  I don’t think it necessarily unwise to, say, invest 50% of entire investment portfolio with Vanguard index funds.  Why?  Because 1) index funds (such as the Vanguard Total Stock Market Index) are diversified — at least in terms of U.S. Stocks.  2) They are transparent… they are clearly invested in market-weighted proportions of the U.S. Stock market.   (Fine print: mostly, with some representative sampling of smaller issues).

The saddest thing I hear about folks who “invested” with Madoff.  Those who invested all, or most of their money.   Some of those sorry folks are likely to go from multi-millionaire to the poor house practically overnight.

The moral of this sad tale can be summed up in two words:  “Caveat emptor”.

  • Understand your investments.  (Be like Buffet… don’t buy what you don’t know.)
  • Part II: If you insist on buying something you don’t know, only invest a small amount (5% or less of your net worth).
  • Diversify:  Spread your funds to a reasonable degree.  This includes not putting all your money with one money-manager or fund.
  • Diversify.  There is arguably no substitute for some money in the bank.  E.g. FDIC insured deposits (subject to $100K, $250K limits per institution).

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