Vail Valley Voices: Lessons from Bernie Madoff
On Monday, Bernie Madoff was sentenced to 150 years in prison for bilking more than $50 billion from scores of investors. During the period leading up to sentencing, many of the people who lost money wrote letters to the judge, urging him to sentence Madoff to the fullest extent of the law.Given that Madoff is 71 years old, the sentence seems like overkill. But the judge wanted to send a message to all con artists that this type of crime will not be tolerated by our court system. Harvey Pitt, former head of the Securities Exchange Commission and frequent commentator on securities issues, said on CNBC that he understood that the judge was trying to make a point. But perhaps a more sensible approach would afford Madoff an opportunity to cooperate in exchange for a future reduction in his sentence that would enable him to be released before his death. Such cooperation could result in the recovery of funds that would be returned to the investors. It seems, however, that the investors cared more about Madoff being subjected to as much punishment as possible than anything else. These same people will soon realize that the current sentence will make it less likely that they will ever get their money back. It should be noted that a great number of those investors who lost money are sophisticated investors. Moreover, many trustees of eleemosynary organizations that were scammed have very capable directors on their boards. It’s inconceivable that so many savvy people could be conned by Madoff into violating all of the rules of intelligent investment.So what was Madoff’s attraction? The media covering this story has indicated that Madoff used several ploys to lure investors into his ponzi scheme, a con in which investors are led to believe that their investments are profitable, but in reality, they’re being funded by their own money or by new investors. A chain letter is a simple example of a ponzi scheme in which the last participants fund the earlier ones and lose their money. Some investors say Madoff was charming. Some were impressed by his seemingly pristine and years-long reputation as a successful investor. But all were motivated by high returns. It’s now been discovered that Madoff’s returns, which far exceeded other investment funds, were nonexistent.Exacerbating the situation is that many of Madoff’s investors reinvested a large percentage of their profits, so “earnings” were never realized.Could these investors have avoided this calamity? Absolutely! If they had followed a few simple rules that are among the first things you learn in any basic investment course, many investors would have lost nothing or would have lost substantially less.There are many lessons to be learned from this unfortunate episode that everyone should consider when they invest their hard-earned money. Here are some points, which I believe are most important:• Don’t invest all of your money with one investment company. Diversification often helps offset losses. Many of the people and institutions that invested with Bernie Madoff had more than 50 percent, and even 100 percent, of their savings with him. The right percentage of funds to invest with one institution is for you to decide, but 50 percent to 70 percent is probably too much. Obviously, if the federal government is insuring your investments, this point is moot.• If the returns you’re receiving, or are supposedly receiving, seem too good to be true, there may be something amiss. You’re being lied to, you’re taking substantially more risk than you think, or you just don’t understand the investments. • It’s impossible to make high returns unless you take risk. If you’re living off of the earnings of your savings, high-risk ventures are not advisable.• If an investment company is not audited by a top-certified public accountant, don’t invest with it. Madoff took in billions of dollars using an accounting firm nobody’s ever heard of. This scam could never have persevered for so long if Deloitte & Touch or Ernst & Young had audited the books.• It’s risky to do business with your family and friends. Your money is at risk, so you should be able to ask all the tough questions you want to ask, even if feelings may be hurt. You may be hesitant to ask pertinent questions if you’re close to your investment adviser.Invest in a basket of securities and cash in diversified industries. Once again, diversification can oftentimes mitigate your losses. If you invest in one company and it goes out of business or declares bankruptcy, you may lose all of your money. Lehman Brothers and Fannie Mae are examples of seemingly well-run and respected companies that devastated many investors.• One last bit of advice. There are many reputable investment advisers in the market who can help the most unsophisticated investors make good choices. If you stray away from government securities and certificates of deposit, it may make sense for you to consult with an accredited adviser. Please recognize that many advisers often have other agendas. For instance, they may be employees of brokerage firms and get paid by generating securities commissions. Try to understand the conflicts that an adviser has before you follow his or her advice.Sal Bommarito is a New Yorker who has skied Vail for 20 years. He will periodically report on national issues that affect Vailites. A former investment banker, he recently published four novels.
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