Would You be Gullible Enough to Invest with Bernie Madoff?

“There are some frauds so well conducted that it would be stupidity not to be deceived by them.” – Charles Cotton

I was reading the book Think Twice by Michael Mauboussin recently (great book for anyone interested in behavioral psychology and how your brain processes information in a counterintuitive way) and he shared a story that appeared in the Wall Street Journal a few years ago.

Author Stephen Greenspan wrote a book called Annals of Gullibility: Why We Get Duped and How to Avoid It. This book came out in December of 2008.

The timing of the book release was actually quite fortunate because it was the same month that the biggest financial fraud in history fell apart.

This was when Bernie Madoff’s Ponzi scheme was finally discovered.

It’s funny that you don’t see much written about financial scams until after they occur. The same is true for articles on how to prepare to invest in a bear market or should you invest in _____? (Fill in the blank with gold, real estate, technology stocks, really anything that has risen in value).

Anyways, what makes this story so interesting is that Greenspan was actually one of the investors that got swindled by Madoff’s fraud. He lost a decent chunk of his retirement savings at the hands of Bernie.

He was nice enough to share his experiences in a Wall Street Journal article after the fact to tell how he, an expert in gullibility, was duped by one of the worst Ponzi schemes of all-time.

Here is his take from the WSJ:

In my own case, the decision to invest in the Rye fund (a feeder fund invested with Madoff) reflected both my profound ignorance of finance, and my somewhat lazy unwillingness to remedy that ignorance. To get around my lack of financial knowledge and my lazy cognitive style around finance, I had come up with the heuristic (or mental shorthand) of identifying more financially knowledgeable advisers and trusting in their judgment and recommendations. This heuristic had worked for me in the past and I had no reason to doubt that it would work for me in this case.

My belief in the wisdom of this course of action was so strong that when a skeptical (and financially savvy) friend back in Colorado warned me against the investment, I chalked the warning up to his sometime tendency towards knee-jerk cynicism.

It’s interesting that he claims one of the biggest reasons for the fact that he missed the inherent risks in his investment with Madoff was that he was ignorant about finance and he didn’t take the time to learn or remedy the situation.

He studied our behavioral biases in great detail but still had a hard time discovering his own natural tendencies to be easily deceived by complex investments.

It’s also very easy to trust those that sound confident on the subject you yourself don’t know much about.  Most people will choose certainty over uncertainty even when that certainty is a mirage.  It makes you feel more comfortable.

This is the case with many people and it’s the reason why so many professional athletes are broke a few years after earning millions of dollars. It’s kind of boring to learn about your finances and it’s much easier to do nothing or pass the buck so a supposed expert.

At the end of the day, it’s your money and no one is going to care about it as much as you do. Remember that when you are looking to make big financial decisions.  Trust, but verify if you are taking your advice from a professional in any field, but especially finance.

This story definitely belongs in the ‘you couldn’t make this stuff up if you tried’  hall of fame.

Why We Keep Falling for Financial Scams (WSJ)
Think Twice: Harnessing the Power of Counterintuition