I recently learned of a book that was written by victims of the Bernie Madoff Ponzi Scheme. It is titled, “The Club No One Wanted to Join: Madoff Victims in Their Own Words,” and it has much to teach about personal finance and investing. Some of Madoff’s victims were retirees who, after decades of frugality, paid off the mortgages on their homes. However, to increase their investment portfolios, they re-mortgaged their homes. This is how one of the victim’s explained their decision: “In the spring of 2003, I had decided to renovate my small but comfortable Florida condo that was completely paid for; the advice given to me by my sage uncle and another financial advisor was to take a ‘little extra’ out in a loan and move it over to Bernie.” ‘Don’t tie your money up in bricks and stones; have it out there working for you. You’ll earn more with Bernie than the bank will charge you in interest.’ So, I did just that and started making monthly mortgage payments.”
Needless to say, this was a mistake. It is perhaps “the” rule of personal finance that your home is not an investment; it is the place where you and your family live. Therefore, it should NEVER be put needlessly at risk. If someone advises you not to “tie your money up in bricks and stones; have it out there working for you” tell them that you do not want your home working for anyone; you want it right where it is, housing you and your family. Then, stop talking to the person because they either do not know what they are talking about or they are a fraud, like Bernie Madoff was. Additionally, many of the victims had all of their money under management with Bernie Madoff. If just half of their money had been with another money manager, their savings would not have been completely lost.
A fundamental rule of personal investing is that your investments should be diversified across several different money managers. Preferably, each of the managers should be large, publicly held firms with plenty of assets of their own, as well as plenty of “Directors and Officers” insurance to pay any claims that are filed against them. Next is the role the government played in the Madoff fraud, which was not insignificant: Madoff was a former chairman of the NASDAQ stock market. He was also investigated several times by the Securities and Exchange Commission (SEC) prior to his fraud collapsing, and was cleared of wrongdoing each time.
Madoff was also sanctioned by the Internal Revenue Service (IRS) in regard to his ability to be an Individual Retirement Account (IRA) Custodian. Given the above, many of the victims felt the government effectively endorsed Madoff, which gave them comfort to give him all of their money to manage. Understandably, they now feel betrayed. It is important to understand that complying with governmental rules and regulations is “table stakes.” This means that all money managers must follow rules and regulations to be in business. Therefore, rule and reg compliance is a minimum investment requirement, not an endorsement. The implications of this are significant.
While you should obviously only do business with someone who is compliant with governmental rules and regs, that does not mean that a compliant money manager is either knowledgeable or even competent from an investment perspective. Therefore, abnormally good investment results, such as those reported for years by Madoff, must always be skeptically and thoroughly evaluated. If you lack the skills to do this, you should not invest with the money manager, even if a “sage uncle” advises you to.
Joseph Calandro, Jr.
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