Harry Newton's In Search of The Perfect Investment
AM EST, Thursday, December 18, 2008: I'm
revisiting and expanding on the lessons we learned yesterday from The Bernie
Madoff Ponzi Scheme Fraud. Thank you Dan Good and Todd, amongst many,
for help. Here we go:
1. Don't get
suckered in by the alleged high returns and dump more money in. If
anything, take your money out. Don't put more money in. It destroys
your portfolio allocation and leaves you hanging, subject to someone else's
whims. Re-balance regularly. There are actually people who gave Bernie Madoff
100% of their portfolio. These people are now broke and being forced to sell
2. Be wary of
Bigger is Better. More money to manage doesn't bring bigger results. In fact,
it's much harder to make big returns with big money. Bill Miller and a zillion
others before him proved that one.
3. More money
and more success bring more hubris. More hubris brings more invincibility.
And more invincibility leads to mistakes, which leads to more gambles and
ultimately to cheating. There's no evidence to suggest that Madoff didn't
do OK at one point. Only when he got too big and things went against him (like
he had to return more money than was coming in) did he resort to lying, cheating
4. Be wary of
people who give large amounts of money to charities. There's usually a reason
beyond the inherent goodness of the charity or their heart. For people in
finance, charity is a sales expense. Madoff was a huge contributor
to many charities, which sadly will now suffer. Every time a finance guy gets
given an award at a big banquet dinner for giving oodles of money, think of
that as his free advertisement -- cheaper and more effective than ads
5. Due diligence
makes sense. But it's not easy, nor is it foolproof. Asking some of the financial
institutions who flunked Madoff would have been a major eye-opener. Societe-Generale
kept its clients away from Madoff -- though it still lost billions with that
6. Don't trust
fund of funds to make your investment decisions. Many put other people's money
into Madoff. But they did virtually no checking. These fund of funds spend
their money and efforts on marketing, not administration. Fund of funds put
another layer of fees and incompetence between you and the ultimate money
manager -- the one who touches your money.
7. There are
actually very few good money managers. All go wrong eventually. No matter
how competent your manager, you don't want all your eggs in one basket.
8. Back test
the strategy. If he's playing commodities and says he's had a consistent 10%-12%
return for the past 10 years, check out if this is plausible. Apparently Madoff's
strategy couldn't work -- because there simply weren't sufficient instruments
to trade based on how much money he had to manage. Read the article in the
9. Don't trust
the SEC, the state regulators or anyone else to protect you. NY AG Cuomo and
his Mass equivalent Bill Galvin did wonders for holders of auction rate securities.
But even that was after the fact, not while it was going on. The SEC knew
years ago about Bernie Madoff and the likelihood that he was running a Ponzi
scheme. But the SEC did nothing. Don't believe me? Read the Wall Street Journal's
Misled SEC in '06, Got off.
10. Don't put
more than 5% of your assets in any one investment or any one manager -- even
if he has multiple funds and other vehicles you can invest your money.
11. Limit your
illiquid investments as a class to 10% of your total investible funds.
Harvard owns timber forests. They're the classic illiquid investment. Harvard
will never sell them. They couldn't today. But they don't need to. They have
enough cash. And they're tax-free. But you're not. You pay taxes. And if you
die, you may have to pay lots of them. The IRS prefers its timber products
as checks, not trees.
12. Be wary
of investing money little known organizations -- especially those where investing
was a privilege. Well known companies will screw up and lose your money. But
you'll rarely lose 100% of your money through fraud.
13. Verify that
a Big Four accounting firm provides annual certified audits. If you're dealing
with a hedge fund, it's reasonable to ask for a copy of the latest report
from the fund's prime broker.
14. Don't invest
in "a magic box," i.e. you don't know what you're investing in.
No one knew precisely what Madoff was doing. But because his alleged returns
were so good, no one seemed to want to find out. No one wanted to break the
15. Some monthly
return statements are not worth the paper they're written on. Anyone with
a $500 laptop and a copy of Excel can make pretty reports. Paper is cheap.
Results are expensive.
16. Be wary
of the Yield Risk, also called The Risk Reward. I remember when "junk"
bonds yielded 15%. You knew by that high yield that they were "junk"
and hence ultra-risky. But 10% to 12% never seemed risky. Yet that's exactly
what Madoff "delivered." He knew if he had "delivered"
a higher return, red flags would have gone up. As the amount of investible
money has skyrocketed in recent years -- think China, Japan, successful dot
com entrepreneurs etc. -- the rate has come down. Personally, I now think
"junk" starts around 7%.
17. Don't sneer
at a peaceful life. A friend retired and put all his money into U.S. Treasuries.
Another fellow put all his money into muni bonds. Neither "investor"
is getting a high rate of return. But their principal is safe. And they can
live on the interest for the rest of their lives. I would have been much richer
if I had taken all the monies I got from selling my business in 1997 and invested
it in treasuries or muni bonds. Instead I chased yield, got taken by crooks
(not Madoff) and bought into bum real estate ventures. Fraud or failure in
the end aren't that different.
Madoff fraud will redefine finance. David Rhoden, a Texas reader, writes:
I continue to enjoy your column....however.....when you continue to say
for investors to do their "Due Diligence"...has become a laughing
matter.....with the scandalous society and financial cheating....how can
any one do "Due Diligence"...?...how can anyone really believe
anything they "see, hear or read anymore"...?......their is no
such thing anymore as to Due Diligence...so many things these days prove
to be false later.....its a sad world.
we can't take anything any longer for granted.
When I ran a
publishing company, our mantra was CHECK. CHECK. CHECK. Many people
didn't check Madoff out.
don't forget to say NO. It's the hardest word in the English language.
But I know you're bright enough to learn it.
from an Ice Storm. Global warming doesn't
mean things are getting warmer. It means the weather is getting nuttier. Last
week we had an ice storm at our country house. We were without power for five
days. We could have frozen busted pipes and a ruined house -- except our contractor
hooked up a portable generator and ran our boiler sufficiently to keep the
needs to have a cold weather strategy. One way is to shut off your water and
drain your pipes every time you leave. Another is an emergency generator --
one that kicks in when it's needed and one that has sufficient fuel to last
your flu shot. There is some bad stuff going around. You don't
want it. Wash your hands regularly.
Ailey American Dance Theater is stunning. You
either like dance or you don't. I do. Here are scenes of incredible, wonderful
dances I saw last night.
This is Judith
Jamison, the company's artistic director and their best dancer ever. I fell
love with Ms. Jamsion sometime in the mid-70s.
The season ends
January 4. For tickets go to AlvinAiley.org.
Buy single tickets. You'll sit apart. But you'll both get better seats.
your teeth in the task at hand. Christmas
is coming. Here's a recipe you won't find on epicurious.com.
New York City "humor":
A man hits a
The mangled bicyclist: What's the matter with you? Are you blind?
Car driver: Blind? Are you crazy? I hit you, didn't I?
a New York subway.
Man to woman: "Be reasonable, Phyllis. I made this date with Rita three
months before you and I were married."
A tourist asked
the cop on the corner. "Do you know the way to the subway?"
He replied, "Lady, I don't think anyone has ever made it that far."
This column is about my personal search for the perfect
investment. I don't give investment advice. For that you have to be registered
with regulatory authorities, which I am not. I am a reporter and an investor.
I make my daily column -- Monday through Friday -- freely available for three
reasons: Writing is good for sorting things out in my brain. Second, the column
is research for a book I'm writing called "In Search of the Perfect
Investment." Third, I encourage my readers to send me their ideas,
concerns and experiences. That way we can all learn together. My email address
is . You can't
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