Monday, December 29, 2008

A Lesson Learned from Madoff

“Those with the biggest financial gains generally had their money managed by Madoff. It was an honor having him handle your fortune. He didn’t take just anybody. He turned down all kinds of people, and that made you want to give the man even more of your money. When he took your fortune, he told you that he would tell you nothing about how he achieved his returns.”-Laurence Leamer, a Palm Beach based journalist, writing in the New York Post, December 13.

Reading this reminded me of past meetings with clients -- during which a client has told us she or he wonders if we should be putting some money into a can't miss investment recommended by a brother, a friend, a son.... It's a hedge fund managed by a brilliant guy with a Midas touch, or stock in a new company started by a genius who has never failed to turn pennies into millions. It's a special version of the American Dream -- that we will invest in the next McDonalds, the next Microsoft, the next Google. It's sexy and exciting and so hard to resist.

But the truth is, picking the next megasuccess is the longest of long shots. Are there indicators that help us identify companies that will be wildly profitable? None that are a sure thing. It's like an ugly twist on the old fairy tale -- where the princess kisses a frog and he turns into her prince. In investing (and often in dating I'm told) you're likely to kiss hundreds, even thousands of frogs before you ever find a prince. Chasing after can't-miss investments is a terrific way to fritter away your money leaving yourself with little to show for it in the end.

Bernie Madoff's investors believed he was different because he didn't promise extraordinary returns. His promise was guaranteed returns of 8-9% each year. The victims convinced themselves that they were not being greedy, just seeking safe, steady returns. But anyone who has been investing in the past 10 or more years knows that there is no way to achieve a guaranteed return that high year after year. Madoff pulled it off while the market was strong, but as soon as returns dropped off he was forced to borrow from Peter to pay Paul. When the bottom dropped out of the market last fall his entire house of cards came crashing down. The cost of Madoff's crimes is truly terrible. We can measure the dollars, but we can't put a number on the loss of trust he has triggered in millions of people around the world who were not his clients but believed something like this could not happen in the American financial system.

Successful investing, like success in other areas of life is the result of keeping at it, putting money away year after year, spreading your risk as broadly as possible by using diversified, publicly traded mutual funds that hold liquid publicly traded securities. Fortunes are not built overnight and you cannot expect to get something for nothing. This is just common sense, but too often we convince ourselves that our own case is special, or a particular opportunity is a once-in-a-lifetime chance, too good to pass up.

If any good can come from this, I hope it is that people learn, once and for all, that when something sounds too good to be true, it almost certainly is not true. It's time we stopped believing in fairy tales.

Annette Simon

Copyright 2009 Garnet Group LLC

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