Looking for Bernie Madoff

If you could get the candid assessment of the financial markets from a lot of investors today, it would probably be something like returns are low and risks are high. That explains why so much money, especially that held by individual investors, remains in bank accounts, money market funds, ultra short bond funds and other relatively low risk places. The financial markets have given us so many unpleasant surprises in the last 3 years, people are afraid the future holds more.

At the same time, with incomes stagnant and inflation increasing (regardless of government statistics and what high ranking government officials claim), many are under pressure to seek higher returns from their savings. There's nothing wrong with looking for a better return. Just remember that, even though we now live in the era of the endless bailout, there still isn't a free lunch. Unless you're a major bank, a sovereign nation, or a very large business corporation. Stocks and lower rated bonds might offer greater potential for profit, but they also offer greater potential for loss. Risk and reward walk hand-in-hand down Wall Street.

Some investment products include guarantees against loss. These often are touted by insurance companies and should be scrutinized closely. The promise against loss is going to cost you. It could be in the form of tight limits on upside returns (i.e., if the product generates a return, the insurance company is going to keep a good portion of it), stiff penalties for early termination or withdrawal, and in other forms. Remember that if the markets perform poorly and your return is zero, even though your losses are also zero, you would have been better off in passbook savings. (That's not a theoretical point; anyone who put money in passbook savings ten years ago instead of stocks is ahead of the market.) While no one knows what the future will bring, investing in a no-lose product doesn't mean you'll win.

Even though many insurance companies might want to sell you a lousy deal, in general they aren't fraudsters. The worst thing you could encounter in your quest for higher returns is the markets magician who claims to consistently produce good, albeit not spectacular yields, day in and day out, year after year. No one can do that, period. If you meet anyone who says he or she can, put your hand on your wallet and run away. Fast. No matter how tempted you are, and no matter how good the sales pitch sounds, don't invest.

The biggest frauds are perpetrated, not because the bad guy lies, but because investors lie to themselves. They convince themselves that lead can indeed be turned into gold. They brush aside contrary evidence and the rationality of naysayers. They want to hear, however improbably, that good returns can be secured with no risk. They seek out the con artists who promise the sun, the stars and the moon.

Bernie Madoff didn't have to find many of his victims. They found him, and they were ready to believe every word of his web of lies. He'll be in prison for the rest of his life. But there are plenty of latter day Bernie's around. Often, the gullible and greedy will find them. As a matter of law, the con artist is liable and should be punished sternly. As a matter of reality, if you go looking for a latter day Bernie Madoff, you'll probably find him. And you'll regret it.

Greed Kills Financial Plans

Today, the Dow Jones Industrial Average fell 358 points, and, at 18.5% below its all time high, is close to bear market territory (defined as a 20% drop). Bonds haven't done well, either, as rising inflation and credit concerns (in the case of corporate bonds) have taken their toll. Foreign stock markets have been dropping, most notably the Indian and Chinese markets that popped so aggressively last year. It seems like almost all standard investments are dogs. What's an investor to do?

Commodities like gold and silver beckon, while oil sings its siren song. But commodities have been on a long boom, and we now know from lessons administered by the real estate market that no boom goes on forever. Over the next 30 years, oil prices will surely rise. But over the next 2 or 3 years, they could fall. Gold and silver are default investments, where people go when nothing else seems attractive. They have limited underlying value, and, as long term investments, haven't kept pace with inflation over the decades. Beware the glitter of precious metals.

Now is the season for snake oil salesmen. They emerge from dark places to tell you what you want to hear. You'll be offered disarmingly simple investments in prime bank notes. Or you'll have the opportunity to invest in technology that turns coal into natural gas, or perhaps sure-fire leases in Latin American real estate.

Maybe you're knowledgeable enough to avoid ostrich farm-type investment opportunties. But can you resist money market-like investments that pay more than money market funds but are said to be as safe? (Many thousands bought into auction rate securities, and have found their money frozen.) How about investments that are guaranteed not to lose money, and may rise if the stock market rises? (Some variable annuities offer these features, only with very steep fees and nasty early redemption charges that may well push the upside below stock market averages.) Did you invest in the stock of banks, brokerage firms and other financial services companies, which did quite well as long as the real estate market kept rising?

What we now see in the financial markets is the risk part of risk and reward. The two go hand in hand. You can't turn a profit all the time, except by accepting the low returns of bank CDs, money market funds and U.S. Treasury securities. Avoid stretching for yield when the investment stretches credulity. Ride out the current downturn. Invest for the long term and you're likely to be rewarded. Be shortsighted, and suffer the consequences. Greed kills financial plans.