How do you smell a rat?
Charles Ponzi, author of the first Ponzi scheme. Source: Boston Public Library
Detecting financial fraud can be challenging. We know there are lots of people who want our money. It takes decades, sometimes a lifetime, to build a nest egg. It’s important to safeguard it. But in the real world people lie, cheat, and steal. Financial products are especially prone to distortion and deception, with complex legal provisions and mind-bending mathematical formulas. How can we protect ourselves?
First, be suspicious. Ask questions. Double-check the answers. If it’s taken years to grow your wealth, spend a few weeks or months checking out a potential advisor’s references and reputation. Second, don’t lose sight of your money. Regular statements—or online access—should be available. Question anything that’s not clear. Third, remember that risk is part of the game. We live in an uncertain world, where unexpected things happen. If someone offers you a risk-free product with guaranteed returns, they’re probably lying. Don’t just walk away, run away and warn off anyone else. One common factor for those swindled by Bernie Madoff was they didn’t probe deeply enough about his investment methodology.
Bernie Madoff mugshot. Source: Department of Justice
Finally, follow the money. It may seem rude, but you should feel free to ask any financial professional how he or she is paid. Incentives matter. You shouldn’t feel that your savings are supporting someone else’s lavish lifestyle.
All this has been written about before – by Shakespeare, of course. In Act 2, Scene 1 of Henry V, the Bard shows how young King Henry uncovers an assassination plot just before he embarks on his invasion – by asking his advisors questions, keeping them close, and examining their finances. That’s how he learns that the French king had suborned three of his nobles. It’s a key scene that shows how Henry has matured from being a young, carefree rascal to a ruthless, efficient sovereign. We need to mature in the same way. We’re the ones that need to look after our finances – by asking questions and following the money.
Because if something sounds too good to be true, it probably is.
Douglas R. Tengdin, CFA