Some lessons of financial markets

Although financial markets are usually very well regulated the world is not the perfect place and periodically huge scams are revealed even in this area.

An investment operation is one which, upon thorough analysis promises safety of principal and an adequate return. Operations not meeting these requirements are speculative.

Ben Graham

According to Graham, it's vital to make sure the principal body of investment is safe. While it's totally uneasy even when dealing with big and seemingly stable financial institutions we remember those cases when for example the 4th largest investment bank ceased its operation in 2008 due to bankruptcy (Leahman Brothers).

Last week it was announced that on the 14th of April Bernie Madoff an American financier has died.

While we already discussed that if you do investments via low-cost funds such as ETFs you will probably do better than if trusted your money to a hedge fund, the story of Madoff investments is a different kind of lesson that every investor should remember of.

Bernie Madoff's fund Madoff Investment Securities LLC has started in 1960, it had an investment management and advisory division which demonstrated better than market results over few decades up until 2008. It turned out that all of its reported trading operations were fake and the firm acted as a classic Ponzi scheme.

Bernie Madoff was convicted with the penalty of 150 years in prison, forfeiture of US$17.179 billion, and a lifetime ban from the securities industry. Many of his investors have lost their money.

You might think that the SEC should have taken necessary measures to prevent this from happening but it didn't.

So what do we suggest? Should you keep away from markets and be afraid? Definitely not! We'd rather advise:

  • estimate your risks
  • only take risks that you can afford
  • think for yourself
  • always think twice and talk to believable people you have around
  • organize a financial cushion for the case if something goes completely wrong
  • use multiple brokers for big investments (usually, a single broker would have insurance for the amount of circa US$100k)
  • invest in ETFs or other that you understand well