Monday, January 12, 2009

Lessons Taught By Madoff's "Victims"

The Bernard Madoff scandal has clearly had a widespread impact across the globe. While the courts decide how to handle this particular situation and the government works on a solution for preventing similar situations in the future, it is important for us to analyze the simplest lesson to be learned from this scandal...

The #2 rule of investing is "Diversification" (the #1 rule as many of you have guessed is "Buy Low, Sell High)...anyone who invests money needs to be sure to spread that money across several different investment vehicles...the old, "don't put all your eggs in one basket" philosophy.

As an investor and an advisor (and hoping not to sound too cold-hearted) I feel two different levels of sympathy for those who I categorize into two different groups of investors in this situation:

1) Those investors who lost everything
2) Those investors who lost something

While most people sypathize more with those who lost everything, I find myself feeling the exact opposite emotions when thinking about these investors...

Those who lost some of their money clearly followed the rule of diversification and therefore I feel that they deserve more of my sympathy. They followed the rules of investing and got burned by a dishonest man...something that is hard to fault them for.

Those who "lost their life savings" or "lost everything" clearly deserve some sympathy since I feel that nobody should be cheated out of even $1, let alone millions. However, these people failed to follow the #2 rule of investing...diversification. While Madoff is clearly to blame for the losses they incurred in his investment scheme, he is not responsible for the fact that they lost everything. The only person they can blame for losing everything is themselves, for the simple fact that they chose to put their life savings into one investment vehicle. Had they taken a step back from greed or trust or whatever emotion it was that lead them to make this horrible decision and instead chose to invest 10, 20, 50, even 75% of their money with Madoff, they would still have some of their money left.

I write this in no way to show sympathy or support for Bernard Madoff, I write this in the hopes that my readers will take a valuable lesson from this scandal and NEVER put all of their eggs in one basket. If your primary investment vehicle is a 401(k) or other retirement plan that invests primarily in your company's stock, now is a time to diversify. If you have all of your money invested primarily in one stock, one sector of the market, or one mutual fund, now is the time to diversify. No matter how safe you feel in your current investments, take the time to look at them closely or take the time to meet with an experienced financial advisor to have them review your portfolio.


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1 comment:

Junior said...

I think a lot of people would call you heartless for suggesting that somehow Madoff victims "deserved" this but I'd have to agree with you.

There were some bad practices at work here, and I'm not just talking Madoff.

Excellent post and I hope some people actually listen to your advice.