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Bernie Madoff Channels Jack Bogle
03/25/2010 3:15 pm EST
Out of the mouths of crooks sometimes comes truth.
And you can’t find a bigger crook than Bernie Madoff.
The convicted mastermind of maybe the biggest Ponzi scheme ever may have stolen $50 billion from individuals, foundations, and charities in the US and Europe, ruining countless lives.
And he’s paying for his crimes. While serving a 150-year sentence in a medium-security federal prison, Madoff was reportedly beaten by a fellow inmate late last year, suffering a broken nose and fractured ribs, according to The Wall Street Journal.
That same article revealed that Madoff spends at least some of his time dispensing investment advice to fellow inmates.
So, what does he recommend? Printing counterfeit Swiss francs? Stealing American Eagle gold coins? Investing in “sure-thing” Broadway flops like Max Bialystock and Leo Bloom?
Not at all. According to a former inmate: “‘He gave me ideas on my index funds.’"
“Mr. Madoff advised him to diversify, saying he should invest in funds that track the S&P 500 index of stocks ‘where my money would be on all the stocks instead of putting my eggs into one basket.’”
And if this good advice weren’t enough, the former inmate said Madoff warned him off day trading. “‘I was trying to get into day trading and he's like, 'That's not for you. That's for individuals like me with millions to spare,'’" he said.”
Pinch me if I’m dreaming, but doesn’t that sound like advice Vanguard founder Jack Bogle might give?
It’s certainly the gist of The Elements of Investing, a short but substantive new book by former Vanguard Group board members Burton G. Malkiel and Charles D. Ellis.
Modeled after The Elements of Style by William Strunk Jr. and E.B. White, the brief guide to English usage that sits on every writer’s bookshelf, the new book tries to boil down decades of investing knowledge into a format average investors can use.
The co-authors previously wrote two of the seminal books about investing—Malkiel’s A Random Walk Down Wall Street and Ellis’s Winning the Loser’s Game.
In this book, they repeat some of the home truths everybody knows but not enough follow: save money, invest early, diversify, and buy low-cost index funds.
“The cold truth,” they write, “is that our financial markets, while prone to occasional excesses of either optimism or pessimism, are actually smarter than almost all individuals. Almost no investor consistently outperforms the market either by predicting its movements or by selecting particular stocks.”
The key word here is “consistently.” Investors can have hot streaks or get in early on a market trend and ride it for a few years, but very, very few can beat the market over long periods of time—say, more than a decade.
That goes for individual and professional investors alike. Voluminous research shows that a tiny number of mutual fund managers can—after fees and trading costs—top the broad market indexes. Mark Hulbert’s own database shows a mere handful of newsletter writers beat the Wilshire 5000 Total Market Index over ten or 20 years.
Warren Buffett, of course, is probably the exception that proves this rule. Who else can duplicate his singular style of patient value investing and active involvement in many of the companies he owns?
A recent study by two pioneers of efficient market theory—Eugene Fama and Kenneth French—shows the number of outstanding fund managers is even smaller than we had thought.
The two professors ran 10,000 simulations of possible returns of 3,156 actively managed stock funds between 1984 and 2006. “They found that outside the top 3% of funds, active management lags behind results that would be delivered due simply to chance,” The Wall Street Journal reported.
That means that of the 3,000 funds studied, only about 100 recorded outstanding performance, and Fama and French said the "‘good funds are indistinguishable from the lucky bad funds that land in the top percentiles.’"
So, picking outstanding mutual funds—especially before they start outperforming the market—is a crap shoot.
Yet after 35 years of research, marketing, and proselytizing, index funds accounted for only 13% of the total assets invested in equity mutual funds in 2008, according to the Investment Company Institute.
That was a nice jump over the 11%-11.5% at which they hovered over the previous five years, and there are signs individual investors are finally, finally moving their money in that direction.
In 2008, writes US News & World Report, “investors withdrew more than $214 billion from actively managed stock funds, while stock index funds saw inflows of more than $47 billion, according to Morningstar. “
“The trend continued in 2009, with investors withdrawing more than $37 billion from actively managed stock funds and about $36 billion flowing into stock index funds.”
“It is happening, but it’s a long time coming,” Professor Malkiel told me in an interview.
And so is broader diversification. Investors have poured more of their money into international funds, and for the last year they’ve emptied their wallets into bond funds of all kinds, because they were chasing yield and trying to reduce their exposure to stocks.
Malkiel recommends the “broadest of the broad index funds,” which would also provide exposure to so-called alternative assets like commodities (through, say, Brazilian-based miners), real estate (through real estate investment trusts), and high-yield bonds and inflation-protected securities, both of which are represented in broad bond index funds, he says.
He doesn’t think individual stocks provide enough diversification for most people, but says that if investors already have most of their money in broad index funds, there’s no harm in occasionally taking a flyer on an individual stock or two.
“I do it myself from time to time, because it’s fun,” he says.
But not, apparently, Bernie Madoff—or at least that’s not what he advises fellow inmates to do.
Isn’t it ironic that the man who bilked thousands by promising steady double-digit returns year in and year out now says his whole enterprise was impossible in the first place?
Only in prison, where giving people bad advice can get you a broken nose or a shiv in the back, did Madoff finally tell the truth.
When will Wall Street brokerage firms, mutual fund companies, and many financial planners do the same?Howard R. Gold is executive editor of MoneyShow.com. The views expressed here are his own.
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