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Madoff’s lesson

America is shocked and people are angry, because they lost a lot of [tag]money[/tag] and the “government didn’t protect them”. Are we in socialism? [tag]Madoff[/tag] provided us with a very good lesson. One of the best actually. Unfortunately some people had to pay a large fee for it. A [tag]ponzi scam[/tag] is well known and one of the rules to recognize it would be: If something is too good to be true, do not trust it.

This scam doesn’t have borders and I found it in [tag]emerging markets[/tag] in Eastern Europe. People weren’t educated enough, so it was very easy to get “new clients” for decades. I could see some [tag]mutual savings banks[/tag] established on ponzi scheme offering 30 – 50% [tag]interest[/tag] on [tag]savings[/tag] while the entire financial sector was providing only 10% or less. Too good to be true. It was back in 90’s. People weren’t educated and maybe they needed some protection. Are the US citizens uneducated as well? I am surprised that they believed in same promises of high interests or gains. On the other hand Madoff did his job brilliantly that he was able to camouflage his ponzi fund for incredible 30 years! What is amazing that he was able to blame his relatives and friends as well. Was he so greedy that he dropped his relatives and friends?
No matter what, he provided all Americans, investing their hard earned money, with a great lesson. Everybody certainly heard or read about [tag]diversification[/tag]. It seems however, that people understood diversification in regards to [tag]stocks[/tag], [tag]bonds[/tag], [tag]options, ETF[/tag]s or [tag]mutual fund[/tag]s. In this case the diversification is about [tag]brokers[/tag] and fund managers as well. Back, in late 90’s I invested with a broker who claimed that all his assets are collateral with a real estate property, so even if he would lose money in the [tag]market[/tag], he could always sell the property and satisfy all clients. Nothing like that happened when he bankrupted because of the fraud. I didn’t believe him a word and invested only part of my money available. I didn’t lose everything. I am surprised that people were able to give Madoff all their money, all their [tag]retirement account[/tag]s and most of them quit their jobs and lived only off of their investments with Madoff. No one asked a question: what would happen if Madoff bankrupts? All of these people invested all their money without any protection and without paying attention to the rule #1 of any [tag]investing strategy[/tag] on the world: “Invest only the money, you can afford to lose.” Such ignorance is amazing and incredible at the same time. I am sorry to say that, but these people fully deserved what happened to them. They diversified their assets by giving everything to a man who turned to be a criminal. The same people are now crying that government didn’t protect them, didn’t tell them, and didn’t lead their hand. They ask: “who can we trust, if not our government?” Wow, what do they think? The answer is simple: trust nobody, only yourself.
Well, I am not writing this post to humiliate those victims of Madoff’s heist. Everybody makes mistakes. I am making them as well and some of them are pretty costly too. This post shall be about how to protect yourself and recognize scams like this.

How to recognize scam

It is very difficult and you should be very suspicious to everything and everybody. Always ask the question whether the results are too good to be true and if so, pay attention to whom you are giving your money and take stringent actions to protect your accounts. If someone is promising you the world, do not trust him. The rule, every successful investor already knows is: never invest based on tips, never let others [tag]invest[/tag] your own money. If you hire a manager, always ask for references and I recommend contacting them personally. Do not trust testimonials given to you by a broker or manager. If your future broker or manager offers you incredible returns within a short period of time, go away. I know, it is temptation to get rich quick, but this happens in fairy tales or very rarely. You can get rich within couple years or months, but it always will be your own work. If anybody else is claiming that he can make you rich with his revealed secret easy steps… one, two, three… go away. Use logic! Always compare what you hear or see with what is most likely possible. Being conservative is advisable. You can also visit investing forums and ask for advice, or you can contact for example American Association of Individual Investors. I believe you can get help there as well. Even though you take all these provisions to avoid scam as much as possible, you still can be fooled. In this case you need further protection to minimize losses if you become a victim of a scam.

Diversify

If you pick your manager or mutual fund who you decided to trust (you still have to trust someone, otherwise you wouldn’t be able to invest at all) you still have to protect yourself. Never repeat the same mistake many Madoff’s victims did when they invested all their money with one guy. Always ask a question what would happen if my broker or money manager bankrupts. If your answer will be: “I would lose everything”, you should do something to avoid it. I understand some of the victims. They invested small amount of money with Madoff and it worked. So they invested more with him. It still worked well. At the end they became so greedy that they invested everything and it still worked well. It worked well for about 28 – 30 years. If you were planning on being dead within this period, you should be satisfied. Otherwise you are crazy. I myself have three investing accounts and I am planning on opening more of them. I have 401k with one broker, stock investing account with another broker, ROTH IRA with a different broker and I am planning on opening another account for options trading only with other broker again. I never buy mutual funds within same funds’ family or same company (approx. two funds within the same broker) and I am even planning on diversifying my bank accounts more than I already have it now. I understand, there is more work to manage so many accounts, but in 21st century with on-line access it is way easier than it was in 20’s or 30’s of the last century. Jesse Livermore or Nicholas Darvas they both invested with several brokers and they managed all their accounts well – by phone or cables. Why shouldn’t we be able to do the same today?

Are you diversified? Never mix your accounts! Do not be greedy when one of your investments start making you huge money. Withdrawing from your other accounts and adding all your eggs into the same basket can cost you everything. You can put more money to your successful investment vehicle from other accounts, but not everything. Always ask the same question: “What would happen when the investing vehicle suddenly bankrupts or goes to zero?” You may end up like some of the victims, who are now claiming: “Yesterday we were millionaires, today we cannot afford paying our bills.”
If your successful vehicle is making you big money, you can reinvest your gains as long as you decide to live off of it. However in this case I like Jesse Livermore’s tactics, which recommends withdrawing 50% of realized gains. He used them to enjoy his investments. He was however confident enough that he could afford to spend all 50% withdrawn from the account. He knew he would make money next month. If you are not as confident as he was, I would recommend saving those money. Save them on your emergency account. Buy a property, which you can sell in case of emergency. Or you can invest these gains in your other accounts by buying funds or other investment vehicles. If you have enough and decided to withdraw 100% of your gains, always save 50% and spend the rest. You can save your gains on high interest accounts and spending them carefully. After your emergency account becomes large enough that you can afford to lose all your investments, then you can start spending all your gains. The goal is to preserve your capital and turn it into a money making machine, which will generate you income you can spend. If a bankruptcy suddenly happens within your entire portfolio, it shouldn’t affect you significantly. The diversification should be done not only within stocks, funds and other vehicles, but among your accounts too. There are many ways how investors can lose their money. It could be a capital loss, bankruptcy, government suddenly changing business rules, wars, catastrophes and fraud. You can protect yourself against most of those loses, so do it and do not relay on anybody or anything, but yourself.


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7 responses to “Madoff’s lesson”

  1. stultgroows says:

    I have heard Madoff committed a suicide in prison. However, investing all your cash to one idiot is idiocy.

  2. Rick says:

    It is a rule #1 to be diversified. People, who saw 10 – 15% gains and blindly gave Madoff all their money desrve punishment. And here it comes! How is Bernie doing?

  3. Brent says:

    Bernie has problem I guess. Those idiots who gave him all their money deserve it.

  4. Villa says:

    Stock Trading

    Great blog!

  5. Penny Stock Forum says:

    Great information, I will be linking back to you and going to look around at your other posts.

  6. Stock Forum says:

    I will be linking back I really like your site keep up the good work.

  7. Joe Matthews says:

    Thanks for sharing this post.I would love to read more of your thoughts in future.

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