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What Bernie Madoff Taught Every Investor

By Dan Caplinger - Updated Apr 14, 2021 at 12:22PM

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You didn't need to lose money because of the convicted felon's schemes in order to learn valuable lessons.

Bernie Madoff died today at the age of 82. Convicted of fraud against a massive group of investors in a Ponzi scheme involving tens of billions of dollars, Madoff remained in prison until his death.

Madoff's story involves a professional investor who had had a successful career before taking things one step too far. Unable to live up to the commitments he had made to the many investors who turned to him for help, Madoff successfully covered up his activities for years. It was only when the financial crisis brought things to a head that the full extent of Madoff's fraud became evident, leading to his arrest, trial, conviction, and 150-year sentence.

As painful as the Madoff episode was for the many investors snared by his scheme, it holds some valuable lessons that every investor can learn from. Perhaps the most important is that even after Madoff's death, the risk of securities fraud remains alive and well.

Wall Street sign with New York Stock Exchange behind.

Image source: Getty Images.

1. It's easy to follow the bandwagon over the cliff

One reason why Madoff was able to sustain his Ponzi scheme as long as he did was that it was easy for new investors to think that they were getting in on a great investment. Early on, Madoff attracted high-profile investors, including prominent charitable institutions. He didn't advertise his business, instead relying on word of mouth from existing clients to bring in new money. By cultivating an air of exclusivity and success, Madoff could largely just sit back and wait for customers to come to him.

Investors need to do their own due diligence to decide if an investment is suitable for them. Relying on friends or business associates for help is common, but it's only the start. If the only reason you invested in something is because somebody else made the same investment, you won't know what to do when things go wrong -- and you risk jeopardizing your relationships as well as losing money.

2. Know what you're investing in

Most investors in Madoff's investment scheme had little or no idea how his purported investment strategy was supposed to work. Few cared. As long as the returns seemed to be coming in -- at least on paper -- many investors were satisfied at what they saw as a job well done. It therefore came as a total shock when they found out exactly what Madoff was doing with their money and why it went wrong.

There are still many investments that are crafted with complex provisions that aren't easy to understand. Even with simple stocks, the businesses that companies are engaged in can be almost impossible for someone outside the field to grasp. You don't necessarily have to become an expert in every industry in which you invest, but you do need to know how you'll make money and what risks there are. Only then can you accurately assess whether you're making a smart calculated risk with that investment.

3. Diversify

When you have a great investment idea, it's tempting to put all your money into it. That's exactly what many of Madoff's clients did, feeling that they'd never be able to match the performance that his investments were generating. That proved to be catastrophic in many instances, as institutions found themselves with huge losses that endangered their entire operations.

No matter whether you're talking about a fraudulent scheme like Madoff's or a completely legitimate yet misguided investment strategy like the doomed Long Term Capital Management experiment, no investment is free of risk. Unless losing everything is an option you're willing to accept, it's always worth it to find a second-best, third-best, and even tenth-best investment idea to go along with your top investment. That way, if things go catastrophically wrong, your losses won't be quite as severe.

A road paved with good intentions

Madoff's death will feel like justice for what many have seen as evil deeds motivated by greed. Yet as Diana Henriques, author of The Wizard of Lies: Bernie Madoff and the Death of Trust, told the Fool's Mac Greer in 2017, neither Madoff nor his clients were as greedy as some believed. In the video clip below, Henriques argues that clients wanted security for their money, while Madoff wanted the adulation and fame of helping prominent charities and other institutions.

Unfortunately, even after Madoff's death, there are still plenty of people out there seeking to take advantage of investors, both through fraud and by more legitimate means. No one can protect your money as effectively as you can, and the Madoff scheme is a good reminder that you have to be constantly vigilant to avoid investments that end up being too good to be true.

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