Some New Year Investment Resolutions

Bernard Madoff is an Object Lesson

As the year comes to an end, most people who have had investments are probably licking wounds. With the S&P index down 40 percent for the year, few investors would have escaped. So, adversity is always a good time to learn some good lessons, and learn them well.

Here are some possible New Year investment resolutions.

If it sounds too good to be true, it probably is. How often have we heard that proverb? Yet still people get suckered and end up losing lots of money. Big returns mean big risks, and big risks kill.

Bernard Madoff is a name unknown to us until recently. We had never heard of him. However, those in an exclusive and very wealthy niche group had not only heard of him, they invested money in his securities business. The returns he provided his investors were outstanding. When you are running a Ponzi scheme you can manufacture extraordinary returns, as long as new investors keep walking in the door and your existing clients leave their money with you. You take your new clients' money and use it to pay out returns to your existing clients—everyone is happy, until the scheme collapses. And getting good returns is the very best way to attract new clients. The prospect of high returns always draws investors like bees to the honey pot.

If you throw in a dose of generosity and charitable works, the lure becomes irresistible. People love to make good money with a clear conscience. Madoff was well known in charitable circles; he was a generous donor; many charities invested with him. The fact that so much good was being done was one more reason not to look the gift horse in the mouth.

But apparently no-one knew how he was able to achieve such good returns. The smart people were the dumb ones who could not figure out how he did it, and declined to invest in something they did not understand. And apparently there were quite a few who made the “no” decision.

That leads us to our second investment maxim: we should never invest in something we don't understand. What we mean is, you do not understand how the money is being made, or where the returns are coming from. Some have applied this maxim in such a way they would never invest in a business where they did not understand how the product was made, or the particular technology, or whatever. But this is not necessarily what we mean. we may not understand all the in's and out's of how a computer works—but we know what functions a computer performs, why people find it has utility, and why they buy them. Therefore, even though we don't understand all the science represented in a personal computer, we know how Dell or HP make money.

But generally the more complex a business is, the more difficult it is to understand, the less attractive it should be as an investment. Once again the dumb money is the smart money. If people had applied this maxim they never would have invested with Bernard Madoff.

But there is a third investment maxim that would have been helpful. Never take advice—ever. Always make your own decisions, and hold yourself completely accountable for the decisions made. If you lose money, it is your fault—no-one else's. Never, ever hand over the control of your investments to someone else who will make the decisions for you. And never invest in something because someone else told you it was a good idea.

The buck has got to stop with each one of us. That helps us focus the mind. Now, we do not mean, of course, that you ought not to listen to others' views and opinions, but in the end you yourself have to be certain that the investment is sound. If we end up investing because of the recommendation of the broker or the adviser or the relative, or the other person who we believe is smart, don't invest.

Professional investment advisers will always be biased towards recommending what will sell. Investments with high returns are very easy to sell. Never trust their advice. We are not implying that all investment advisers are crooked or dishonest, as Madoff clearly has been, but that they are in business to make money, and money depends upon transacting investments, and there is an inevitable bias towards those investments which are easy to transact. The advisers may genuinely believe in the merit of the investment. They may recommend it honestly. But stay away from it—unless you understand it thoroughly, and you yourself come to believe in its merits. Let's remember, the dumb money is the smart money: don't try to make our dumb money smart by listening to advisers who we (and they) believe are smarter than us.

A good test is to ask yourself whom you would blame if you lost all your money on an investment. If it is someone other than yourself, the chances are you have probably invested very unwisely.