What this tale of Wall Street’s largest Ponzi scheme, perpetrated by the infamous Bernie Madoff, should teach investors.
I highly recommend this docuseries on Netflix. Very entertaining; not only do you have the intrigue about how someone could have bilked investors out of more than $20 billion dollars, but it also does a great job of reminding you of the historical backdrop in the decades his Ponzi scheme took place.
As I watched, a lot of realities came up about what kind of person could act out such a duplicitous scheme for decades: an unstable personality, did not look people in the eye, very flashy, etc. But setting aside Madoff’s personality defects, the biggest takeaway that should terrify investors is that not only did the regulators investigate Madoff more than three times—each time declaring him legitimate—he also convinced large institutions like hedge funds and banks, who managed money on behalf of clients and pension funds, to invest in his scheme. Everyone involved had a fiduciary duty—and none of them kept it. Madoff himself was at one time part of the regulatory body creating the industry rules he was breaking.
Most importantly, protect yourself.
Bernie Madoff can teach investors a few important things to consider before they hire someone to manage their money:
Where is your money being held? You should not be giving a money manager direct access to your account. Instead, your funds should be in your name and housed at a custodian. A custodian is a financial institution that holds customers securities for safekeeping to prevent them from being stolen or lost. Custodians tend to be large reputable firms such as banks. Large, well-known custodians are: Bank of New York (BNY) Mellon, Pershing, JPMorgan Chase, Schwab, or T.D. Ameritrade. (This list is not intended as an endorsement of any of these companies. There are plenty of other reputable custodians, but be sure to do your due diligence.) In my company’s case, our custodian is Pershing. We also go another step and have a broker-dealer—Woodbury Financial—who facilitates our asset management services with back office, technology, regulatory, and operational support.
What is the investment strategy? Throughout the entire documentary, Madoff refused to explain his “strategy.” Investing successfully does not require a top-secret decoder ring nor is it reinventing the wheel. New strategies are not being developed and implemented each day or week. Rather, time and time again the single strategy that works consistently is to buy and hold and grow your money with the market. This is the strategy I encourage for self-directed investors and implement with my own clients (and in my own personal portfolio). If there is another strategy being proposed (and not explained), this is a red flag.
Complexity does not indicate breadth of knowledge. Madoff not only refused to explain his strategy when questioned, but insinuated it was very complex and proprietary. In the end, it turned out he was claiming such complexities existed to hide what was the most basic robbery—robbing Peter to pay Paul. On a much smaller scale, I often see complexity built into client portfolios by managers as a means of “proving” their worth. At Chisholm, because our asset management services include comprehensive financial planning, our value is inherent in working with us. We keep our portfolios simple, low cost, and straightforward. At the end of the day, if your investment advisor cannot easily explain to you what your portfolio is holding and why the returns are as they are, it’s time to move on.
Are the portfolio returns reflective of the broader market? Bernie Madoff claimed to make great returns consistently, even during periods of down markets. With the exception of a lucky stock pick, which I compare to betting on the right horse at the track, an investment manager will not beat the market and certainly not consistently. If he or she is claiming some clairvoyance that the rest of the market does not have, something is not right. When we discuss investment portfolios with clients, we are open and honest about how they will fare in up and down markets and make sure the client knows that investment growth requires various levels of risk—and is alwasy subject to down cycles of the market.
Other Takeaways
There were a few other takeaways that I may address in later stacks. One, large facet of the documentary that I think deserves its own spotlight is the lack of virtue not only of Madoff, but all those so greedy around him. They willingly became blind to obvious discrepancies in how the firm was being run. A society lacking virtue will find itself in these predicaments more and more commonly—even with as many rules and regulations as exist to try to avoid them. Virtue and how it relates to the earning and investing of money is an important topic, and one I think is overlooked.
The other observation that might be worth thinking about for all of us who may be tempted to take the “short cut” is that Bernie Madoff had a successful business separate from his Ponzi scheme (at least until he had to raid that business to keep the Ponzi scheme going). Imagine what his story could have been had he stuck with his successful and legitimate investment business. He could have built a nice life for himself and his children while helping other people do the same. Instead, the flashy life tempted him to engage in truly immoral acts that instead of making his life easier —as the wrong path often promises—
filled his life with stress, heartbreak, and ultimately destroyed his entire family and the lives of those who he financially ruined.