The latest financial fiasco is a private hedge fund run by Bernard L. Madoff that was found to be a giant Ponzi Scheme. The whole decades-long swindle bilked investors to the tune of $50 Billion dollars. 

Will new regulations prevent investment scams like this in the future? No. This stuff has been going on throughout human history. It’s obvious to most, but the fundamental problem with investing scams are they are run by liars. You can’t regulate liars. You can only diversify against and try to avoid being entangled by them. 

Liars come in all forms and wealth levels. Enron had perfectly fine books for years according to the regulators and auditors. It was just that their executives and accountants were lying about everything.  Then there’s the recent real-estate bubble. Many people who took out sub-prime mortgages lied about their income to buy a home they couldn’t afford. Mortgage brokers sold those loans to banks while lying about the credit quality. Investment banks then took pools of these mortgages and bundled them together and lied about the safety. Investors bought those mortgages thinking they were getting above market returns with little risk and lost a lot of money (they were lying to themselves). 

Regulations can’t make liars honest. Ponzi schemes like this have been illegal since the dawn of modern securities regulations and they still happen. Liars are creative so you need to protect yourself against them.

So what should you take away from this incident? Several things:

1) Diversify your money across multiple asset classes and financial institutions.

Even the most well-established company, bank, money manager, brokerage or mutual fund company can run into problems some day that could threaten your investments. Also, some investment asset classes may run hot for years and then suddenly crash with tremendous losses. You don’t want to have your money so concentrated that you could lose it all if something unexpected happens. 

2) If something is too good to be true, it probably is. 

It’s amazing how much money this simple rule could have saved people through the ages. 

3) You can’t cheat an honest man. 

Many cons rely on the dishonesty of the victim as part of the act. Promises of easy profits by using dubious, gray area, or outright illegal methods are always warnings to stay away. 

4) If you don’t understand how an investment works, you should avoid it.

If an investment is complicated with many layers and moving parts it may have unknown risks. Same for investments where it is unclear exactly how the returns are being generated. If you don’t understand 100% what you’re investing in, then don’t invest. 

If someone is offering an investment and is promising they can beat the market consistently with little risk you should run away. You worked years to save your money and you simply can’t risk losing it following the primrose path of easy wealth. Nobody has a shortcut to wealth, but there are many shortcuts to poverty. 

No related posts.