How to Spot an Investment Con (So You Don't Fall for the Next Madoff)

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Big nosed lying salesman
Alamy
He may be festering in prison for the rest of his life under a 150-year sentence, but Bernie Madoff is still in the news. This week, we learned that JPMorgan Chase (JPM) is settling charges against it for its supporting role in Bernie Madoff's scam by paying $2.5 billion in penalties.

The investors whom Madoff bilked lost about $17.5 billion in principal. Thanks in large part to bankruptcy trustee Irving Picard, those investors are actually recouping more of their investments than you might have suspected. Picard has recovered more than 50 percent of the lost money -- about $9.5 billion. Adding in the JPMorgan penalty, all told, the total he has regained for those victims is about two-thirds of what they invested in the fund.

That's great for the defrauded folks, but don't let it have you thinking that you, too, might get most of your money back if you fall for some Madoff-like scheme. That's not likely. Instead, learn what red flags you ought to watch out for, so you don't end up a victim.

Heed Warning Signs

JPMorgan itself outlined some of those red flags in its eventual warning about Madoff to U.K. authorities: "The investment performance [of the Madoff funds] is so consistently and significantly ahead of its peers ... as to appear too good to be true -- meaning that it probably is.''

Consistency of returns in an investment is clearly a desirable thing, and you can get it -- in bonds or CDs, for example -- securities that have a fixed interest rate. But stock prices are in constant flux, as is the stock market. In 2013, for example, the S&P 500 gained a whopping 32 percent, whereas in 2008 it shed even more than that -- 37 percent. Madoff, meanwhile, was reportedly returning 1 percent per month, every month, over many years, with never an annual loss. If someone promises you consistent returns stock market, look closely -- or just run away.

That's especially true if the consistent returns are high, as in the case of Madoff's promise. The stock market, over many decades, has averaged an annual return of close to 10 percent. If someone suggests that you'll earn, say, 15 percent or 20 percent regularly, be very skeptical.

Warren Buffett is a rare investor who averaged annual returns of 20 percent or more over several decades, but this is key: He never promised such returns. Indeed, students of Buffett will see that he repeatedly urges investors to be realistic, and warns that his future returns will likely be smaller than his past ones, as his company grows ever larger. (Between 1965 and 2010, Buffett's Berkshire Hathaway (BRK-A) averaged 20.2 percent annual growth of its per-share book value, versus just 9.4 percent for the S&P 500. Its average has since, as he foretold, inched below 20 percent.)

Another warning sign of a problematic stock investment is a return that's guaranteed. You might, for example, run across "guaranteed" returns when penny stocks are hyped as part of a pump-and-dump scheme. (Indeed, penny stocks, trading for less than about $5 per share, are almost a guaranteed loss.)

Be wary, too, if there's any "trust me" attitude in the air. Madoff investors were receiving statements from Madoff himself, not from a reputable financial services firm. (He was even collecting their investment dollars personally, not just fees for his services.) Don't even trust your friends or relatives if they urge you to invest in a certain way or with a certain individual. Madoff made money via friends recommending him to other friends. Classic Ponzi schemes often operate that way. In short, don't trust others too easily with your hard-earned money.

And Keep in Mind...

Finally, think critically about any investment proposition you run across. Don't let yourself quickly assume that any one is safe.

In the Madoff case, most accounts were with JPMorgan, which would have made any questioner feel somewhat secure. It can be hard to imagine that one of the world's largest financial institutions would be involved in such shenanigans. But it can happen -- and it did.

The bottom line is that if an investment seems too good to be true, it probably is. Do your own thinking, and avoid investments you don't easily understand. That way, you can avoid falling for the next would-be Madoff.

Longtime Motley Fool contributor Selena Maranjian, whom you can follow on Twitter, owns shares of Berkshire Hathaway and JPMorgan Chase. The Motley Fool recommends Berkshire Hathaway. The Motley Fool owns shares of Berkshire Hathaway and JPMorgan Chase. Try any of our newsletter services free for 30 days.

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24 Comments

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chrissf4529

just a opinion: Madoff will get a presidential pardon for " health reasons" ,much like Pincus Green and marc Rich received.

January 14 2014 at 11:04 AM Report abuse +1 rate up rate down Reply
Greg and Mel

Chase bank is a ponzi scheme at least if they own and service your mortgage! We made every mortgage payment every month, on time, for 16 years. Suddenly we began to receive late notices, late fee charges, and phone calls from Chase demanding our house payment. Talking to Chase and reminding them we are not even involved in the payment transaction as they electronically withdrawal it every month from our bank account, and that it is stated on our bank statement they took it every month without fail, and our account was with CHASE themselves, made no difference. Our home was our investment and they pocketed our hard earned money and demanded more despite all the documented evidence against them and our demands to Chase to find our money they took, they did nothing but threaten foreclosure! Yes, before you make an investment, make sure you are working with a reputable investment company, and your money is not being stolen. We are not the only people Chase has done/ is still doing this to, but it wont end until they are held responsible and stopped, which no one that's responsible for stopping them is doing!

January 13 2014 at 4:42 AM Report abuse rate up rate down Reply
1 reply to Greg and Mel's comment
miriamisrael1

I second that

January 13 2014 at 8:41 AM Report abuse rate up rate down Reply
ecurbwlbruce

The next Madoff is already here. Obama is ripping the American people off with mandated, Obamacare that will bankrupt America. It has already cost American workers thousands of jobs and for their existing, affordable and good healthcare to be cancelled. It's time to repeal obamacare and impeach Obama.

January 12 2014 at 4:35 PM Report abuse -2 rate up rate down Reply
chrissf4529

comments again display how effective the Political parties have been in dividing this country. Most comments blame one or the other political party. And, guess what? Our politicians read these comments and laugh.They realize if we keep fighting as voters and defend the inept or corrupt behavior of a leader with 'Look at what the other party did", they need fear nothing. Voters will vote party line strictly (Illinois is a great example, voted in two candidates who were dead, one who is legally insane, and re-elected a politician under investigation for corruption). Stop making political stories out of investment artices, or tv shows, or articles about cooking. And, realize "soundbite" comments do far more harm than good.

January 12 2014 at 11:01 AM Report abuse +4 rate up rate down Reply
1 reply to chrissf4529's comment
miriamisrael1

well said

January 13 2014 at 8:43 AM Report abuse rate up rate down Reply
richard_larson52

Hey guys you forgot the most important one of all......
If a MORMON, ANY MORMON comes up to you and says hello!

January 12 2014 at 10:54 AM Report abuse +2 rate up rate down Reply
alfredschrader

He what if we got a bunch of celebs to show up and give a brief speech. I bet we could sell a lot of ad time on tv. What if we gave each of them an award, then they would show up for free to get the award. Would have to be something catchy. How about Golden Globes, or Oscar ?
Could make millions and only have to give out fifty bucks worth of statuettes.

January 12 2014 at 9:43 AM Report abuse -1 rate up rate down Reply
bakeland

Sazal Khan!

Yeah, right.

You're maybe the one that this article warns about.

January 11 2014 at 6:23 PM Report abuse -1 rate up rate down Reply
nrwlbt

The Republicians trickle down fairy dust is the biggest con.

January 11 2014 at 11:30 AM Report abuse +4 rate up rate down Reply
1 reply to nrwlbt's comment
betty_brock

You like the Dem trickle up poverty?

January 11 2014 at 8:10 PM Report abuse -1 rate up rate down Reply
k4jlp

Take a look at the movie "Wolf of Wall Street" (but don't take the kids) and you will see some of the stuff going on. And no I don't belive ALL the movie. Traitors PRODUCE NOTHING, they only scam money from the Commodity Market never even taking delivery of the "product" adding to the cost of EVERYTHING we need. The transfer of wealth continues.

January 11 2014 at 8:00 AM Report abuse +2 rate up rate down Reply
alfredschrader

Here's the insider scoop: Half of Buffett's funds are in cash and cash equivalents.
Buffett didn't get there with his investor savvy. He doesn't even know what a megabyte is.
He did it selling insurance and he's not even good at it. The king in the insurance business is
Met Life. Did you know that Met Life assets, the assets that result from selling insurance, are nearly one trillion dollars ? Yep, almost 1,000 billion dollars.

January 10 2014 at 6:21 PM Report abuse -5 rate up rate down Reply
1 reply to alfredschrader's comment
hgeorgech

Al ... why didn't you also include Barry O's comment ... "he didn't get there on his own; he had help .. who built the bridges, the roads he used, etc., etc" ... who CARES how Mr Buffet made his fortune ... the fact is, he DID IT ... have YOU?? .. or are your comments just plain old "sour grapes"?

January 11 2014 at 5:42 AM Report abuse +3 rate up rate down Reply
2 replies to hgeorgech's comment
alfredschrader

I've done quite well. Buffett making a fortune is great. People saying he's some kind of an investment genius, well I don't see it and I'm insulted.
Most insurance salespeople wont sell you a policy unless they are certain you'll never collect on it. Buffett is an insurance salesman, English speaking GEICO lizard thing included.

January 11 2014 at 8:00 AM Report abuse -4 rate up rate down
alfredschrader

How many GEICO ads have you seen or heard in the last 24 hours ?
Buffett making money is great, that's what capitalism is all about.
My issue he is saying it's his investment skills that resulted in his success, but it is not.
He made it selling insurance to people that almost never collect on it.

January 12 2014 at 9:51 AM Report abuse -1 rate up rate down