Bernie Madoff, who swindled thousands of investors to the tune of over $10 billion by way of his infamous Ponzi Scheme, passed away last week while serving a 150-year prison sentence. [1]  While Madoff has become known as one of history’s most notorious fraudsters, he had been well respected within the financial industry even serving as chairman of the Nasdaq exchange.  He was able to use his esteemed reputation as a financier, and leverage some common behavioral biases to fool his victims.  I will share with you some tips to avoid becoming victim to investment scams and avoid costly mistakes when selecting an advisor.   

[1] Source: Associated Press  

Do your homework when selecting an advisor.                                                                                 

While many investors prefer to delegate the day-to-day management of their portfolio to a financial professional, it is important to do your due diligence.  Even though there are many folks in our industry that hold themselves out as a planner or advisor, they may be little more than a salesperson.  You should know that those helping with your hard-earned wealth are properly licensed to sell or advise you on the particular financial products you are considering.  Additionally, you should understand how your advisor is paid (commission, fee, or a combination of both) as well as what services you should expect to receive from them.  Will the person you are considering only be helping with the upfront purchase of investments?  Will they periodically review your portfolio and rebalance based upon your situation and market movements?  Do they provide ongoing financial planning services in addition to helping you invest your money?  These are all important things to know and understand when selecting an advisor.   

As of June 2020, anyone working for a brokerage firm or financial advisory firm is required to provide you with a Client Relationship Summary (Form CRS) prior to opening an account.  Anyone providing you with investment or financial planning advice for a fee, is required to provide you with a Form ADV (Parts A & B) detailing the services offered, fee schedule and information on the advisor’s background.  You can visit brokercheck.com to see that the person and firm they work for is properly licensed with FINRA and/or the SEC.   You may want to ask if they have earned any additional designations as well as if they have experience working with clients like yourself. 

Do you understand the advisor’s investment philosophy or strategy?                                                      

While it turns out Bernie Madoff wasn’t investing client funds at all, he reported very consistent returns of around 1 to 2% per month.  Harry Markopolos was the first to uncover the suspected fraud and alerted the Securities and Exchange Commission (SEC), the Federal regulatory body for investment advisors.  He had determined that the returns that Madoff was reporting were not mathematically possible. [2]    

It is likely that many of Madoff’s investors overlooked potential red flags, due in part to their own greed.  While his returns were not necessarily outstanding, they were overly consistent.  All investments, even the safest investments like cash and government bonds carry some type of risk as shown in the chart below.  Remember that there is no free lunch, risk and return go hand in hand. 

[2] Source: Investopedia

Some advisors may prefer to select individual stocks and bonds based upon their own research or try gain an advantage by timing their entry into specific investments or sectors.  Other advisors may prefer to invest your money in lower cost investments and own a broadly diversified portfolio rather than trying to outguess the market.  Regardless of which strategies they use, it is important that you understand the rationale and that they incorporate your needs and risk tolerance when recommending an appropriate portfolio.  Warren Buffett once famously said, “Never invest in a business you cannot understand”.  I believe this also applies to any investment strategy you are using. 

Ensure funds for investment are deposited at a third-party financial institution (custodian).  

In the case of Bernie Madoff, he was acting as both the Investment Advisor and custodian for client accounts.  By doing both jobs, he was able to manipulate client statements and coverup the underlying fraud.  In order to provide more safety and transparency, most advisors use a third-party financial institution to hold client funds. Prior to investing your money, you should ask the following questions. 

  • What financial institution will be holding my funds and is responsible for sending me statements and tax documents?
  • How often can I expect to receive statements and by what means (paper, electronically)?
  • Can I view my account online if I choose?
  • Is my money tied up for a specific period of time and subject to penalties, or can I gain access to the funds easily when needed?

Be skeptical of investments or advisors that appeal to ethnic, religious or political affiliations. 

Madoff was able to gain a large clientele of wealthy Jewish families, foundations, and charities because he was very prominent in the Jewish community and was “like them”.  In the polarizing political climate we find ourselves in, I would be cautious of advisors that wear their political or religious affiliations on their sleeves as they could be using it in an effort to undermine your trust.

It is easy to believe one would be able to spot a potential con-artist or scammer like Madoff a mile away.  Unfortunately, greed and fear are excellent motivators and even our own overconfidence can leave us more susceptible to getting fooled.  Take the time to ask the right questions and build a long-term relationship based on trust with a financial professional.  We would be delighted to hear from you to answer any questions you may have. 

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Disclosure

Visionary Horizons, LLC nor any of its representatives provide tax preparation or advice.  Please consult with a tax professional prior to implementing any strategy.  Registered Investment Advisory Services are custodied at Schwab Institutional, a division of Charles Schwab & Co., Inc. (“Schwab”) Member SIPC., TD Ameritrade Institutional, a division of TD Ameritrade, Inc. (“TD Ameritrade”) Member SIPC. 

Securities offered through Purshe Kaplan Sterling Investments, member FINRA/SIPC, Headquartered at 80 State Street Albany, NY 12207. Purshe Kaplan Sterling Investments and Visionary Horizons, LLC are not affiliated companies.

NOT FDIC INSURED. NOT BANK GUARANTEED. MAY LOSE VALUE, INCLUDING LOSS OF PRINCIPAL. NOT INSURED BY ANY STATE OR FEDERAL AGENCY.

Nick Hughes, CFP®
Nick Hughes, CFP®
Nick Hughes, CFP® is a Wealth Advisor with Visionary Horizons, LLC, a Registered Investment Advisory Firm in Chattanooga, TN.  Nick has been helping retirees and widows simplify their financial lives and develop more clarity about their future since 2007.  He has contributed to articles for Market Watch and FinancialPlanning.com and is a regular contributor to the Visionary Horizons blog.