THE BIZOP NEWS

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After the Madoff Ponzi, we can expect a number of checklists that explain how to "avoid" Ponzi schemes.

These checklists will look reasonable, be put forth by well meaning people, and are utterly useless.  They will fail to address the psychological factors which dispose an individual to act against their own self interest.

Here is on such checklist.

1. Don't invest in something you don't understand.

The attraction of Madoff's investing philosophy was that he employed what is known as a "split-conversion" strategy. OK. Stop right there. I would guess 99 percent of you reading this have no idea what that means.

I didn't.

I had to call a hedge fund manager who runs a very sophisticated computer-based derivative operation to explain it to me. "It's not a magic bullet or a secret sauce," he told me. "It's no big deal, but there's no way to get the returns he did doing this strategy."

After talking with him for a few minutes I can tell you this stuff is serious gobbledygook. Greek to us mere mortals. You want nothing to do with it. Avoid it like the toxic waste that it is.

Ok, do you understand what IBM, Google, or even Berkshire Hathaway does? No, you don't otherwise you wouldn't be reading this, you would have no need.

2. There is no such thing as a free lunch. The beauty of Madoff funds is that they supposedly returned 1 percent a month, every month. Like clockwork.

They consistently provided above-market returns with no volatility.

They were just as safe as comparable funds, only with higher returns.

Puh-leeze! That is a financial "push-me pull-you." An animal that doesn't exist.

This is marginally better as advice, unfortunately it presupposes a sophisticated understanding of risk and reward. That understanding generally doesn't exist.

3. Diversify. I know I know; that's Investing 101. Yet my poor neighbor had all of her retirement money in a Madoff fund. All of it. You just can't do that.

Again, this is just wrong. Diversification works if you have different uncorrelated investments. Very few investments remain uncorrelated in a crisis, so even if you were diversified by purchasing uncorrelated financial assets, in a crisis all of the bad assets would trade as if the same bad asset. Diversification is an academic tool, which has pluses and minuses, but you would do well to take Mark Twain's advice: put all your eggs in one basket, and watch that basket very closely.

4. Don't stand for no or low disclosure. I was looking at my neighbor's "statements" from Madoff and they were ridiculous.

Nothing in them. Just "balance at the beginning of period," "balance at the end" kind of stuff.

Why bother with all the other numbers? What's the matter, you don't trust us? I did note the fund would only let her take money out twice a year. Nice.

Reasonable, except even legitimate mutual funds have disclosure statements which are impossible to dope out.

5. Be wary of no-name operations. I'm not saying you couldn't lose your dough in a Fidelity or Vanguard fund or a Merrill brokerage account through fraud. But I will say it is much less likely.

By many orders of magnitude. And if your money is in a bank under the FDIC minimum, well then, of course it carries a government guarantee.

In the case of Madoff, folks would whisper, "I know this guy who does great. You've never heard of him, but he's better than everyone else." Yeah, right.

This is probably the worst advice. It fails to deal with basic psychological trick Madoff used: entrance into the Groucho Marx Club. Groucho famously didn't want to be a member of club that would accept him as a member. That was the Madoff club: you couldn't belong, but maybe just maybe a guy I know, who knows a guy can get you in.