Content Matters

As others have pointed out, there were clearly signs that something was wrong with Bernard Madoff's returns to those who care to do the required due diligence. But beyond that, there are lessons to be learned, particularly for individual investors.

First, I think individual investors tend to fall into one of two groups: those who are actively interested in investing and are willing to commit 10+ hours per week to their portfolio, and the rest of us.  I think the first group is probably no more than about 1% of the world, though my guess it that closer to 10% might think they fall in that group.

For those who are avidly interested in investing, that's great. Take part of your porfolio (the percent depends upon your risk profile) and actively invest it yourself. You'll know what you hold and you can monitor your results using various websites. Perhaps you'll want to follow others' strategies. If so, choose a site like Covestor, where you can monitor real results, rather than those that may be reported by a firm.

For the rest of us, trying to beat the market is a loser's game. You can chase the performance of whichever fund managers were hot last year, but they'll probably underperform the market this year or next. Or, you can act on your gut instincts and tips from others, but keep in mind that the 3-5 hours per week you spend thinking about the market are unlikely to let you outperform those who manage money for a living.

To me, the best approach is to determine your asset allocation strategy, either using various web tools or by taking advice from a fee-based financial planner. (Note: I would only use financial planners who charge you a rate for their planning advice and who do not invest on your behalf). Then, pick mutual funds to match your asset allocation targets. For large cap US equity, I'd always use index funds, as you end up basically buying the S&P 500 anyway, so why pay 90 basis points or more for that. For international equity you can either index or pick a few managers who've put up consistent 5- and 10-year numbers. For small cap, I'd go with actively managed funds with a good track record as well.

Is this sexy? Will it outperform the market over time?  No, in both cases. But as recent events have shown (and even performance in more stable markets) most active managers fail to beat the index each year anyway. You'll have a diversified portfolio that matches the market and you'll be unlikely to wake up one day to learn that your nest egg has disappeared due to fraud. If, like me, you do like doing some stock-picking, keep 20% or so of your portfolio for your own stock picks.  You can enjoy your wins and learn from your losses, knowing that your overall portfolio remains secure.

As for the investment advisors and brokers who put their clients into Madoff without proper due diligence, I could write a book about them but will save that for another post. For now, let it simply be a reminder that their guidance is often no better than your own and typically has their interest in mind.