If you’ve been following the news about Bernard Madoff’s alleged $50 billion Ponzi scheme, perhaps you've questioned your own investing know-how — and that of the financial pros in charge of your money.
It appears that Madoff duped some very smart, very savvy people. New York Daily News owner Mort Zuckerman reported that his charitable trust lost $30 million in investments with Madoff. At least two charities have been forced to shut down in the wake of the scandal. One unfortunate investor told The New York Times that his two children's college funds had been completely wiped out, and he's almost certainly not the only one. With such an array of victims sharing stories of vanished investments, it's natural to wonder how it happened — and whether it could happen to you.
Embrace Diversity
The Madoff scandal reminds us of a fundamental principle of investing: diversify your portfolio. A well-diversified portfolio is important for any investor because it lessens risk by offering protection from any catastrophic losses that a single investment vehicle might suffer. But diversification is especially important for older investors and retirees who don't have the time to recover major losses. (It's been heartbreaking to see that so many elderly investors lost everything because of their reliance on Madoff.) Diversification is also crucial for investors whose funds are earmarked for specific use in the near future — like paying for grandchildren's college tuition.
To me, a well-diversified portfolio means not having more than 20 percent of your investable assets in any one investment. For example, many of my clients have 20 percent in a "growth" mutual fund, 20 percent in a "value" mutual fund, 20 percent in a real estate fund, 20 percent in an international fund, and 20 percent in cash. (I’m a big fan of mutual funds because they are more highly regulated than individual stocks.)
All Things in Moderation
It is possible, however, to go overboard and have a portfolio that is too diversified. I've had new clients come to me with investments in as many as 30 different mutual funds. The problem there is that if any investment does especially well, it will only have a minimal effect on your overall worth. What you want is for each piece of your investment pie to have enough significance so that it will have an impact if it goes up. Not only will individual investments in 30 different funds fail to make a significant impact on your wealth, but they will also be nearly impossible to follow.
Keep Your Eyes Open
Keeping up on your investments — and your investment manager — is another important way to protect yourself and the legacy you're cultivating for your grandchildren. Even with the recent bad news, I don't think anyone should panic and automatically distrust the people who handle their investments. But you should be as well-informed as possible, and ask tough questions of the people to whom you entrust your funds. If you’re with a mainstream brokerage firm, ask how often they get audited. (I get audited at least once a year.) Also ask how much you are insured for, and who the insurer is — you should be insured up to the amount of your account's value, by a major financial-insurance carrier.
| Do you have funds for your grandkids? |
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Yes; and they've taken a huge hit 35.7%
Yes; they've done better than other funds 4.8%
No; but I need to start 23.8%
No; and given the market, I'll wait 35.7%
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You should also make sure you're receiving — and actually reading — quarterly statements and prospectuses from your broker. This information should always come from a major brokerage firm, bank or trust company, and should be on the institution's official letterhead.
Everything I've read indicates that Madoff's clients believed he was employing a traditional prudent investment strategy that provided good, steady returns. Ironically, that consistent success may have been a savvy investor's only red flag. As too many people have now learned, even a seemingly stellar investment can go awry. Diversity remains your best defense against devastating losses that can impact not only your future but also that of your grandchildren.
Next article in Finance: Investment Advice for Uncertain Times
Also see: Tips for teaching children the value of money, ways to leave a legacy to your grandchildren, and how to turn kids into philanthropists.
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