Back on Dec. 13, Barry Ritholz penned a great article about the ten lessons learned from the Madoff implosion. You can see that article here.
I have been thinking about some of the things that Ritholz said and would like to make some comments on a few of the points.
5. Know What You Own: Do not invest in anything you do not understand: How does this make money? What makes this unique? What is the basis for this investment? What are the risks? If you cannot answer those questions, you should not be risking your capital.
Boy can I relate to this one. About six or seven years ago when everything was going up, up, up I got talked into buying a large position in a fund of hedge funds. I knew absolutely nothing about the investment, but trusted my FA and took the leap. Several years later I told my (now new) FA that I wanted out of that fund of funds. It took four months for that position to unwind. I recovered my principal (lucky) and learned a terrific lesson. From that day hence I vowed to never invest in any instrument that I did not understand. I have stuck with that to this very day.
6. No Outsourcing: Do not outsource your thinking or due diligence. Do not rely on 3rd parties, fund of funds, lawyers, advisors or consultants. We have learned that most are worthless. What is the value add does this fund manager provide? What are they doing, and should I be doing that myself? This is true for consultants, economists, strategists, traders, and managers.
My FA is a good guy and he brings me a lot of good ideas. Some I like, others I don’t. In the end, if any investment I make takes a dump, it is MY PROBLEM. FA’s are just that – ADVISORS. When push comes to shove, if something that I have my money in takes a dump it is my fault and I am the one that bears the brunt of the consequences.
This opens up a discussion about FA’s in general. Do I really need one? Probably not. But he has brought me interesting ideas and products that I would have no clue existed if he were not there. If I had to run my complete portfolio myself I think it would just be a plain ‘ol mix of stocks and bonds, rather than the diverse and varied investments that I have now. I am not even sure I would have access to many of the products that I own without a FA, but I don’t really know. In the end, I think he is worth the money I pay him.
7. You must not keep all of your money with one manager: I was astonished how many people had all their money with Madoff. If the worst happens, this is a recipe for disaster. Diversify your holdings across several professionals in unrelated firms.
I am not so sure that I agree with this one 100%. I get the drift of what Ritholz is saying. But in the end, my accounts with (insert large broker here) are owned by me. So if you have ALL of your money in Merrill or B of A or whoever it really is your money. You own the stocks, bonds and all the rest. Madoff, being a private entity was different.
The only way this could fail in a bad way would be if (insert entity here) was printing and emialing you bogus statements that said that you owned xx shares of company abc. I have a hard time believing that this could happen in any of the large, publicly owned companies that are reputable. That said, I do not have all of my eggs in one basket.
I would like to add one that I read somewhere else. Nothing is free. I don’t like seeing those quarterly withdrawals from my account that my FA gets, but you gotta pay the man. If I don’t like it, I can always close the account. Plain and simple.