Sunday, December 14, 2008

Con Artists

The recent charges of fraud against Bernard Madoff, once a prominent Nasdaq market maker, remind us that, amidst a financial crisis involving complex financial instruments and obscure investment vehicles with names like SIV, conduit and SPEs, there still remains room for plain old con artistry. If true, the charges against Madoff would demonstrate that people who want something too much are easy victims, and that there are plenty of smooth talkers ready to take advantage of them.

Think back to times you were out on the town. It was 15 minutes to closing time, and you still hadn't hooked up with anyone. You didn't want to go home alone, and people who hadn't looked so good an hour ago were starting to look better now. What did you do, and did it turn out to be a mistake?

With the stock market down 40% plus, real estate still dropping, and even commodities falling in value, investors may become desperate for yield. Beware. This is the hour of the con artist, those crooks that prowl the country club circuit, cocktail parties and even church socials for victims. The more you want something, the more likely you might believe someone who promises it to you. Your emotions can work against you. Be dispassionate and skeptical. Think about how hard it was to accumulate the money you have, and how painful it would be to lose it. Don't swing for the fences because would-be home run hitters strike out a lot. The same basic principles that governed investing before the Civil War still apply today.

If it's too good to be true, it probably isn't true. One of the allegations against Madoff is that he delivered remarkably steady earnings, in both good times and bad. Many people want certainty in an uncertain world, and a clever crook can take advantage of that desire by promising and appearing to deliver six impossible things before breakfast. The sad thing is that some people might buy into the scheme. Don't believe that certainty is possible, except with the very low returns offered by U.S. Treasury securities and FDIC insured bank accounts. Otherwise, be cautious and skeptical. The financial markets are volatile and even the best sometimes lose money (Goldman Sachs and Morgan Stanley, two of the Street's most prominent firms, are expected to report losses this week). Someone who claims to be able to consistently outperform the market is promising something that's too good to be true.

Diversify. News stories about the Madoff case report that some individuals and nonprofits may have lost most or all of their money. If so, then they violated one of the cardinal principles of investing. Never put all your money in one investment or one place. Diversify. In the final analysis, investors can't know for sure if a person is a crook. (See our blog at That's why you should never put all your eggs in one basket.

Greed Kills. Greed kills financial plans. If you're desperate for yield and willing to believe that you can beat the odds, you'll become careless and miss warning signals. As in many other walks of life, if your goals are reasonable, you have a pretty good chance of attaining them. Investing for reasonable yields so that you'll have a comfortable retirement is more conducive to long term financial security than betting the ranch in the hope of getting yourself into the Forbes 400. If you look for something that's almost impossible, you probably won't get it.

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