Monday, June 22, 2009

Maddoff Schemes and 5 More Financial Pitfalls

Bert Whitehead, M.B.A., J.D. © 2009

You probably know someone who knows someone who invested in Maddoff’s Ponzi Scheme. These ‘investments’ pay handsome returns, but not because the money is actually invested, but because investors who cash in on their ‘profits’ are paid off with cash received from new suckers.

With the recent market collapse, we are hearing of more and more of these frauds. That’s because these scams run out of cash when people take money out faster than new ‘investors’ are putting new money in. As Ben Bernanke quipped, “When the tide goes out, we can see who’s naked.”

This blog will discuss the Maddoff scheme as well as other classic ways investors lose money in investments -- and how you can protect yourself. Some of the safeguards I will discuss have been outlined in a series of articles by my colleague, George Marrotta, a Research Fellow at Stanford’s Hoover Institution which I have linked if you are interested in perusing.

1) The simple rule that Maddoff’s investors ignored is: “Don’t Let Your Advisor Have Custody of your Investments.” Maddoff’s investors sent their money directly to him; the paper statements they received were made up by him and his staff. Using Schwab or other independent custodians allows you to review your statement directly on-line at any time. Always make out your checks to Schwab with your account number on it, and check your statements to make sure the deposit was received. Cf.

2) Even with the safeguard of having an independent custodian custody your assets, it is still possible to get embezzled. There were recently two cases which individual advisors stole several million dollars from client accounts. In these cases, the advisors had very elderly clients and instructed them to sign transfers from their Schwab accounts to the advisor’s account, or the advisor had check writing authorization on their account.

This of course could happen to any of your accounts at a bank. The safeguard is simple: Make sure you review your bank and brokerage statements yourself every month and review withdrawals and transfers out to make sure you know what they were for and you received the money.

3) As we get older, it is much more difficult to keep track of everything in our lives. Your finances are one of the first areas impacted by old-age forgetfulness. If you find yourself becoming confused and forgetful with your finances, it is important to have someone in your life that you trust to review your finances with you. They can double-check to make sure mistakes aren’t being made. Where we notice that a client is becoming forgetful, we will bring it up and suggest a neurological exam, since this condition can greatly impact your financial situation if not dealt with appropriately.

4) The biggest scam I see our clients exposed to are private investment ‘opportunities.’ These usually have very nice glossy sales brochures and a salesman/organizer with a smooth line of snappy patter. These often involve unregistered securities which are virtually impossible to evaluate because there is not adequate financial information, disclosures, conflicts of interest, etc. to work with. We suggest you don’t even consider unregistered securities, even with (or especially with) friends and family. Time-shares are one of these scams.

5) If offered the opportunity to get in on the ground floor, ask them to email you a prospectus or ‘offering memorandum.’ I review a number of these deals every month for clients. Then I explain the risks involved, how the money is being used including payment of the organizers, the conflicts of interest involved, etc. This is the information which is technically ‘disclosed’ but that most people don’t read or understand. Once these factors are explained, clients generally take a more sobering approach to these deals.

6) It is also important to recognize and avoid financial hooks. In many investments the salesperson earns hefty commissions. This is disclosed in the fine print which no one reads. One clue is that you are charged a hefty surrender charge or penalty to get out in the first 5-10 years. For more information, go to

I do believe that a financial advisor should save a client more than the advisory fee charged. Often the savings in taxes, lower investment costs, avoiding commissioned products, insurance evaluation, getting better mortgage deals, etc. produce savings which are readily apparent.

But over my 37 years of doing financial planning, I think I have saved clients even more money by talking them out of inappropriate investments and keeping them from getting scammed.

If you have been dissuaded from an investment by your advisor, I’d like you to let me know about it. I’d like to do a blog someday on ‘Investment Horror Stories!’

Wednesday, June 3, 2009

How Long Does It Take to be a Long-Term Investor?

Bert Whitehead, M.B.A., J.D. © 2009

This year’s market bottom in March wiped out all the market gains in your portfolio since 1996 (13 years)! This has left many commentators sniveling about the stock market as an inferior investment vehicle. But I’m sure everyone reading this has consistently been told that you have to be a ‘long-term investor’ to profit in the stock market.

So if 13 years isn’t long enough, how long is long enough?

When I started as a Financial Advisor in 1972 we were in the recession that started in 1967. The Dow hit 1000 in 1967 and didn’t get beyond 1000 again until 1982 (15 years). There was a widespread belief in the 70’s that the market could never go over 1000.

The financial pundits at that time subscribed to the theory that whenever stocks went beyond 1000, companies would always issue more stock. The additional supply would force the stock prices down, So the supply/demand curves intersected at 1000.

This year the market bottomed at 6600 in March ‘wiping out all the gains’ since 1996! But if you look at the peak in 1982 when the Dow was at 1000 and compare it to the peak in 2007 when the Dow hit 14,000, the market rose 9.8% per year ‘peak-to-peak over that 24 years. Clearly the ‘permanent market cap’ at 1000 the academicians theorized has been discredited.

Even measuring the ‘trough-to-trough’ bottoms from 607 in 1974 to 6600 this year (25 years), the market increased an average of 10.0% per year. On top of this add in the 4-6% in historical dividend payouts and the total average annual returns are easily over 12%.

The stock market has consistently been the most accessible investment over the long term! These kinds of returns are available to every person by simply consistently dollar-cost-averaging into a large cap indexed mutual fund over the long term.

Deciding not to invest in the market now, especially for younger people, could be the worst financial decision you could make in your life. And remember: you are younger now than you will ever be for the rest of your life .

This analysis explains why Cambridge Bond Ladders are for 15 years, rather than the 5 years many other advisors suggest. Fifteen years cash flow will last you through any recession. To fully reap the profits of the stock market an investor should have a 25 year horizon. That’s how long is long enough!