Four Tips For Avoiding Being Ripped Off By Your Financial Adviser

Four Tips For Avoiding Being Ripped Off By Your Financial Adviser

By now everyone has heard of Bernie Madoff and his $50 billion (with a ‘B!’) investment scam. Unfortunately, although his scam was by far the biggest ever uncovered, he was hardly alone. There’s Roberto Heckscher, who allegedly bilked $50 million from mostly elderly investors over a thirty-year period. And, more recently, Kenneth Starr, a New York investment adviser who represented many actors and celebrities, was indicted on charges of stealing at least $59 million from his clients. All of these people were reported to be charming, persuasive, and credible. How can you protect yourself from losing your life savings to such a swindler?

There are actually a couple of very simple things you can and should do to ensure you do not become the victim of an investment scam.

First of all, make sure your adviser uses an independent custodian to hold your assets. The advisor should be limited just to making trades in your account(s), deducting any fees for his or her advice, and getting copies of statements. If Madoff had operated this way he could never have gotten away with his scheme. An additional benefit of this approach is that you will receive periodic statements from both your custodian as well as from your adviser, giving you the opportunity to make sure they match.

Next, know what you own. Stick to stocks, bonds, mutual funds, and ETFs that are publicly traded and listed on major exchanges like the New York Stock Exchange. They are valued independently at least daily, if not minute-by-minute, while the exchanges are open. You can check their reported returns against your own portfolio. If you can’t find your investments in the newspaper or on the Internet, that’s a red flag. And while some might argue that there are non-liquid alternative investments (such as credit default swaps) that can outperform publicly traded investments, most such opportunities are generally highly risky. With more than 8000 different mutual funds available (according to the Investment Company Institute), it’s hard to justify the need to invest in non-public alternatives for most investors.

Third, remember the adage, “if it’s too good to be true, it probably is!” Madoff claimed consistent returns of between 10% and 12% per year for over a decade with little volatility and no losses. We’ve never seen any investment that even comes close to having such a record.

Fourth, don’t put all your eggs into one basket. Common sense tells us that diversification decreases risk. Modern Portfolio Theory further demonstrates that proper diversification actually improves returns. Why would anyone want to put all his or her money into a single investment?

You can also research the adviser with the SEC at www.adviserinfo.sec.gov, with FINRA (an independent regulator for securities firms doing business in the United States) at www.finra.org/Investors/ToolsCalculators/BrokerCheck/index.htm, or with the regulator for your state at www.nasaa.org. Unfortunately, none of these checks would have revealed problems with any of the advisers named above. Hopefully the financial reform legislation enacted by Congress will improve the capabilities of these regulatory agencies to uncover fraud before it gets so far out of hand.

We will all inevitably encounter persuasive people with a low standard of ethics in many areas of our lives. When it comes to investing, following the four tips above should go a long way towards preventing them from taking advantage of you.

 

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