About 50 seats were set aside in the courtroom today for people who lost millions because of Bernard Madoff. I hope they got some satisfaction, however weak, when he said, "I'm deeply sorry and ashamed" as he pleaded guilty. One can only wonder what they were thinking.
How did the investors ignore the warning signs that now appear obvious to everyone? The answer seems simple to me: the promised returns seemed too good to pass up. Madoff promised consistent returns of 10 percent to 12 percent and delivered -- or at least it appeared his investment strategy delivered on those terms. But it didn't really, as we have learned. Some even question whether he invested at all. Based on information from the trustee investigating the firm, there were no actual trades in at least the last 13 years.
So how did 4,800 investors get drawn into the scheme? Madoff created an aura where people were made to believe they were part of an exclusive club allowed to invest with him. He offered consistently better returns and did so for many years. Then people who were benefiting from these returns told their friends. Everyone assumed their friend had fully vetted Madoff, yet many of those who did take the time to check him out decided to say no.
And that provides a good lesson: Don't ever invest in something without doing your own research, no matter how close a friend you are with the person who recommends it.
All the investors who lost everything made the classic investing mistake of putting all their eggs in one basket. Always remember that you should never put more than five to 10 percent of your assets in any one investment. A good investment may report that your returns may be 12 percent one year, six percent the next and just two percent the next, so you can expect a return of about 6.67%. Don't believe anyone who promises 10 to 12 percent consistently each and every year.
What can you do to be sure you're not caught up in the next Madoff type Ponzi scheme? Here are some tips:
* Don't pick an advisor who prominently touts his ethics, honesty and trustworthiness. Anyone who aggressively promotes his honesty is raising a red flag. Madoff's Web site bragged, "Clients know that Bernard Madoff has a personal interest in maintaining the unblemished record of value, fair-dealing, and high ethical standards that has always been the firm's hallmark."
* Be wary of an advisor targeting a particular ethnic group. Madoff did this by targeting wealthy members of the Jewish community.
* Avoid advisors who ask you to make checks payable to him or his firm. The only check you should make payable to an advisor is for his fee. By not depositing your money with your advisor, he will not have access to or control of your assets. Checks should be made to the custodian holding the assets.
* Avoid advisors who do their own statements. A national or regional firm should be the one who issues your statements. Statements should come from a third party or custodian of the funds.
* Take a close look at who's auditing the books. Madoff hired a small auditing firm. Be sure your advisor works with an accounting firm that does the books for many large investment firms.
* Don't believe anyone who promises consistently high returns year after year. It's not possible. No one has been able to offer steady returns of 10 to 12 percent legitimately. All types of investments have up and down years. Madoff promised those numbers, but delivered on them by using new investments to pay returns to older investors -- a classic Ponzi scheme.
* Don't invest in something that involves an investment strategy you don't understand. Madoff refused to explain how he produced investment returns and clients joked that he put the money in a "black box."
Lita Epstein has written more than 25 books including "Trading for Dummies" and "Reading Financial Reports for Dummies."
What's your investing game plan?View Course »