Learning from Expensive Mistakes

Dear Clients and Friends:

As always, there are two ways of learning in life.  You can either be taught how to do something the right way or learn from the consequences of doing it the wrong way.  This concept is especially relevant in the world of investments where it is advantageous and less costly to learn from others’ mistakes.

As many may recall back in November of 2015, two San Fernando Valley men were sentenced to multiple years in prison for running what prosecutors have called “one of the largest Ponzi schemes ever seen in the Southland” (Fred Shuster, Los Angeles Daily News).  The $134 million Ponzi scheme lasted a duration of 13 years, hurting many people along the way.

According to prosecutors, hundreds of millions of dollars were lost by more than 1,300 investors who were falsely told that their money would be used to purchase ATMs that would generate annual profits of at least 20 percent.  In other words, the two con men told investors that each would pay a flat amount to buy a specific ATM that was to be installed at a specific location and that they, in turn, would pay the investors 50 cents per transaction performed at their particular ATM while guaranteeing annual returns of at least 20 percent on each ATM.  The con men were the owner-operators of Calabasas-based Nationwide Automated Systems Inc. (NASI), which guaranteed to place, operate, and maintain the ATMs.

To further the scheme, the con men allegedly sent phony payments to victims that were deemed to be related to their investments.  As it turned out, the monthly payments did not come from profits.  In fact, the money came from other investors, which is typical in Ponzi schemes.  In other words, the payments weren’t revenues from the ATMs, but were instead from money the men had collected from new investors.  The worst of it, however, was the discovery that the two con men were fabricating and sending out bogus monthly reports to the investors that falsely depicted the performance of the investors’ ATMs.  They even included a “non-interference” provision in the lease agreements that prevented the victim-investors from visiting the locations where their ATMs were supposedly located.

The scheme damaged numerous families by not only causing them to lose their life savings, but also forcing them to sell their homes.  One victim broke down when describing how he and his family had no choice but to sell their home of 20 years.  He explained to the court, “We were stripped of our sense of community and dignity” (Los Angeles Daily News).  The fraudulent scheme ultimately left the individual investors struggling to make ends meet, plan for retirement, or simply pay for necessary health care or provide for family members’ medical expenses, education, and other basic needs.

Although NASI did service a small number of ATMs, which were owned by the company and not investors, the overall operation was a scheme.  We strongly urge investors to do their due diligence, question returns that seem too good to be true and be wary of fraud.  Investors should also consider putting safeguards into place to protect their life savings and avoid putting their entire life savings into a single investment.

When choosing investments, and deciding how to diversify, it is important for investors to understand risk and return.  Of course, one cannot expect to get a return without accepting some risk.  However, not all risks are worth taking and so investors should ensure that they understand the investment before committing to it.  Investors should also be suspicious if someone is offering a “low-risk” investment with a return well above the risk-free rate.  When deliberating on the risk/return tradeoff, investors should consider their risk tolerance and have a realistic understanding of their willingness to withstand large swings in the value of their investments.  This is because one may panic and sell at the wrong time if he or she has taken on too much risk.

History has shown that rather than sinking your life savings into a single high potential return investment, it is far better to spread your risk across a range of asset classes.  This means investing in domestic and developed market equities, emerging markets, local and global bonds, listed property, and cash.  Investors are advised to also diversify as much as possible within each of those asset classes.  Fees also matter a great deal as a fee of 1%, 2%, or 3% can add up to hundreds of thousands of dollars over the years.  As we saw with the San Fernando Valley Ponzi scheme, the rewards in heavily marketed schemes ultimately go, not to the end investors, but to the promoters.

The best way for an investor to accomplish their goal is to get truly independent advice.  Independent advice means avoiding the guidance of an advisor who is being compensated by the sponsor of the product he is recommending.  A truly independent advisor should structure a diversified portfolio that reflects an investor’s needs, not a portfolio that earns the advisor the highest fee possible.  A good advisor is one who will understand your risk tolerance, your financial situation, and your investment and lifestyle goals and objectives.

Although ordinary investors cannot control market outcomes, they can learn from these lessons and avoid anything that seems like conflicted advice, promises high returns and low risk, indicates lack of diversification or high fees, and appears to be slick marketing.  If we don’t learn the lessons based on the experiences of others, we risk having them taught to us directly or learning from the costly mistakes ourselves.

We hope you found this week’s topic both informative and useful.  If you would like to set-up an appointment to discuss investment questions or concerns, please contact Steve at 818.449.3122 or steve@berkson.net.

Very truly yours,
Berkson Asset Management, Inc.
Registered Investment Advisor
Steven M. Berkson, CPA\PFS, CFP®, MBT

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