Financial Diversity, Risk, Profit & Loss

A guy on the radio today was complaining that he lost all his money invested with Bernie Madoff.  He made his money with many years of hard work in the NY garment industry and Madoff took it all, according to the report  I know we are all supposed to feel sympathy or even outrage.   He was the victim of a crook you could understand how he lost SOME of his money. But this guy claimed to have a couple million dollars invested, all of it with Madoff.   When you money like that, you have the capacity to diversify.   If you diversify you don’t lose ALL your money.  Although what the newly poor old guy describes might be a personal tragedy for him and from his point of view, it is not a random outcome and it was not beyond his control.   

You have to ask yourself why somebody might have so much invested in one place, why they insisted on putting all their eggs into one basket.   The answer is never flattering.    The least offensive is that the basket keeper is just ignorant.   More likely are elements of sloth, greed & a flexible definition of honesty. 

This is certainly not the first time people have been caught up in this sort of scheme and it won’t be the last.   Many financial histories begin with the South Sea Bubble or the Dutch tulip mania, which was the first recorded speculative bubble way back in 1637.  The patterns are clear.   Somebody offers the prospect of unusually high returns with minimal risk doing something that is difficult to understand.   They often are also exclusive and have the slight odor of something skating near the edge of the regulations.   That is ostensibly why they can make the big bucks.  Ironically, they also sell the schemes by implying that the investment is safe because it will be protected by regulators.  The regulations provide a kind of cover that encourages credulous investors to take greater risk.  They  think they are clever, cleverer than the average people with their pedestrian investments. 

If it sounds too good to be true, it probably is.   There is nothing wrong with making risky investments.   Risk is how you make high returns, but you need to understand what risk means.   Risk means that you are trading a greater chance of losing part or all your investment in return for the chance of making more money.    You can manage risk by diversifying your investments.   A good number of investments that are individually very risky can be low risk when they are put together.   You might lose all your money in one investment, but you gain enough on others to make up for it. Nobody can predict the future, so the only way to protect yourself is to spread your assets.   

You can still lose big money, as almost everybody has in the recent hard times, but you won’t get wiped out.  You get problems when you try to identify the ONE winning thing. Never do that. This is Investment 101.

If you went back in time before the crashes and told investors in Madoff/Enron/Keating/etc that they should be getting money out of these things and spreading their risk, most would have turned you down.   They were making the big bucks and wanted to keep on making them. How stupid would you have to be to take money out of such winning investments? 

A couple years ago, I watched a program about a bunch of the victims of Charles Keating.  I saw one angry old man who actually tried to spit on Keating. I think it was the same guy who sat with his son for an interview. His son was a financial planner and he asked why his father didn’t ask for advice before sinking all his savings into this investment.  The old man answered honestly, “Because I knew you would tell me not to do it.” He wanted the returns and figured he could get it risk free.  A fool and his money …

Anyone who promises very high returns w/o risk, is lying and/or doing something dishonest and anybody who still chooses to invest is stupid or dishonest or both.   With the freedom to choose comes the responsibly to choose responsibly.  

It is too bad that the old guy on NPR Radio will have to find a job at Wal-Mart or Seven-Eleven, but according to what he said himself, he gradually liquated all his other investments so that all his money was left with Madoff.  You don’t do that even when investing with someone who is perfectly honest because shit happens.  I guess some people have to learn that for themselves and something we have to learn as a society every couple of years.