In recent interview with MarketWatch, convicted fraudster Bernie Madoff answered questions and sounded warnings to investors (interview below).
Comment: There’s great benefit in financial education & little downside to mitigating risk... so ensure that you are an informed investor... regardless of the size or value of your investment portfolio!
Here is the BesterInvestor – “investment logic always trumps stupidity” – summary response to some of Sital Patel’s questions and Madoff’s answers, as reported in the interview, entitled:
Madoff: Don’t let Wall Street scam you, like I did
If investment looks too good to be true, it is, says Ponzi scheme architect
MarketWatch: You have worked with some of the most elite financial firms on Wall Street. How has it changed since before you started the Ponzi scheme?
Bernard Madoff: The individual investor is the last person that has any information. The average investor is coming up against professional financial firms, hedge funds and the professional trader, and it’s easy to be scared out of the market.
BesterInvestor (B.I.): Individual investors who refuse to get educated deserve whatever returns they achieve. The market is not a favorable venue for gamblers; it requires informed decisions in order to achieve sustainable investment growth, compounded.
MW: Hedge funds are playing a bigger and bigger role in the market, but you point out that they might scare individual investors away.
B.M.: Hedge funds are a danger to the market and need to be registered. A major flaw on Wall Street is exempting hedge funds from being registered if they contain less than $100 million.
B.I.: While there would be no harm in registering hedge funds, it is disingenuous to claim that hedge funds are a danger to the market… people who commit fraud, lie, and cheat clients are a danger to the market and investors, rather than hedge funds.
MW: What about the big brokerages and advisers?
B.M.: Brokerages and advisers should have independent custodians and the government should have forced me to have an independent custodian. Client funds should be held by independent custodians.
B.I.: This is a good idea, especially the last sentence immediately above. That is, unless the client operates a self-directed investment account.
MW: Where is the safest place to invest money these days, with the least amount of risk for fraud?
B.M.: The best chance for the average investor is to put money in an index fund. There are lower commission rates and more professional management with these types of firms. It’s the safest and least likely place to get scammed. If you want to hold money with brokerage firms, go with major public firms. Chances are they will go with proper procedures and proper compliance. If regulators were checking my firm, they would have caught me sooner. This way you can avoid the mistake of putting your money at risk. Or, put your money in mutual funds, which are large enough to protect investors. If you are risk adverse, you should buy municipal bonds or government bonds. If you are not sure, you should put your money in a savings account; at least it’s better than losing money and safe from fraud.
B.I.: Madoff’s advice above is simply bad, or at least superficial. Index funds (like mutual funds and ETFs) invest in other equities, like stocks. In order to sell you the index that the fund company had ‘created’ they will charge you ongoing management fees. The compounded cost of the management fees will devalue your investment significantly over the medium- to longer term. Any investor can build his or her own index fund at a $0 ongoing cost (this blog offers many examples). Madoff’s advice for investors to ‘park’ their money in municipal- or government bonds – or worse, a bank savings account – illustrates what an inept financial advisor he actually was. Even the stodgy Dow Jones Industrial Index (of 30 large-cap stocks) has delivered almost 7% annually for the past 100 years. That’s about… hmmm, 20x the annual return (interest) on a savings account? Suggesting safety in brokerage- or major public firms is another dubious recommendation… remember Lehman Brothers, Bear Sterns and others?
MW: What if the firm says an investment is too complicated to understand?
B.M.: Wall Street is not that complicated. If you don’t understand something, then don’t invest in it. People asked me all the time how did I do it, and I refused to tell them, and they still invested with me. My investors were sophisticated people, smart enough to know what was going on and how money was made — but still invested with me without any explanations. Things have to make sense to you. If you don’t understand the investment, don’t put your money there.
B.I.: Good advice, although the mention of his “sophisticated and smart” investors – especially with the benefit of hindsight – devalues his comments somewhat. I’d offer that his investors were more greedy and gullible than sophisticated and smart, but the people who lost money would likely disagree.
MW: How should an individual investor get to know Wall Street and how it works?
B.M.: Read good books. You have to educate yourself on the market. People are very gullible. Scamming investors has been going on since the beginning of time, and I don’t think it’s going to end. Use a qualified adviser. There used to be registered advisers that were educated and qualified on different financial investments. We don’t have that anymore. The biggest danger is when advisers have incentives to steer investors one way or another to get a bigger paycheck, which can happen.
B.I.: All good advice up to the point where he says, “Use a qualified advisor.” How would you know? My preference would be that investors get educated, build their own index fund, set their investment goals & holding period, check in frequently to gauge performance & perhaps re-balance, and benefit from reinvested dividends and compounded returns. No unsophisticated investor should be trying to time the market or be playing with put or call options, short sales, etc. It is simply not necessary or worth it... and chances are good that they'll lose money!
MW: Your customers were given consistent, good returns for years. No one realized it was a Ponzi scheme until the financial crisis and clients demanded their money back.
B.M.: If it sounds too good to be true, it is.
B.I.: Come on... the question itself assumes some credibility and standing for Madoff's investment firm! The implied returns achieved we now know was 'just rubbish', and mostly a quest for ongoing supernatural investment returns, mostly driven by investor greed. Very few customers actually benefited from "consistent, good returns for years"… the majority likely saw regular investment statements reflecting fictitious account balances and returns! And yes, “If it sounds too good to be true, it is.”
MW: How do you make sure your money is really there?
B.M.: What investors should do is periodically ask for your money back, whether it’s at a hedge fund or other investment firm. They will try to stop you by saying you can’t come back if you take it out, but you will likely always be able to go back.
B.I.: A better option: in a self-directed brokerage account you can deposit, withdraw, buy, sell, etc. as much or as little as you wish, and as often as you wish. You should never have to “ask for your money back.” It’s your money! Any investment advisor should consider themselves personally fortunate if you show any trust in them, as potential custodians of your hard-earned cash!
The original interview is available via the MarketWatch website here