Just last month we shook our heads in disbelief over how a middle-aged nurse could give $400,000 to a Nigerian email scammer. Now, we must collect our jaws from the floor once again as ask exactly how hedge fund investor Bernie Madoff could defraud thousands of very wealthy investors out of $50 billion.
In the British TV series Hustle, about a group of London grifters (conmen), the characters frequently repeat a mantra: “You can’t con an honest man”. After all, cons need one thing to be successful: greed. The con requires not only the greed of a dishonest conman, but also the greed of a mark; a sucker who wants something for nothing.
It would seem Madoff’s investors-turned-victims were no different. They may have been famously wealthy and well-connected, but Madoff investors were, essentially, suckers. I’m not saying they are to blame for what happened to them. Madoff committed a horrendous crime and, for nearly ten years, the government failed to notice Madoff (or investigate any number of tips the Securities and Exchange Commission received about him). I do, however, suggest Madoff investors share some traits with everyday suckers.
Whether they were introduced to Madoff by friends or aggressively sought him out, Madoff investors were attracted by one simple thing: His ability to earn steady higher-than-average returns year-in, and year-out.
Madoff’s returns were not eye-popping. They were ten, maybe 12 percent annually. They were believable. The trouble is, even the best investors have down years. That’s the nature of the markets. But Madoff was never down.
Next came the fact that nobody could point to exactly how Madoff was making his money. Nor would he tell you. Until recently, hedge funds were shrouded in some degree of secrecy, but everybody understood they made money by trading securities just like everybody else. Yet when queried, Madoff wouldn’t identify a single stock he bought or sold.
Still, year after year, investors poured billions into his funds. They were blinded by “easy money”. Something for nothing. Steady, solid returns. Some gave Madoff their entire fortune. Multi-millionaires are now, almost literally, penniless.
Sadly, the Madoff scheme won’t just affect the ridiculously wealthy. Many charitable foundations invested in him. Here in Boston, the generous Shapiro Foundation lost over $100 million, which will greatly reduce the grants they are able to give local hospitals, colleges, and charities.
It’s easy to play armchair quarterback today after so many people were duped for so long. Warren Buffett is famous for saying, “it’s only after the tide goes out that you see who is swimming naked.” Still, the Madoff scandal holds a valuable lesson for investors—especially young ones:
If you don’t understand how an investment makes money, don’t buy it. And always, always, always, diversify.
Want to learn more? Read how to recognize and avoid a Ponzi Scheme.