In March 2009, Bernie Madoff pled guilty to running a massive Ponzi scheme while billing himself as an investment advisor to his clients. The story is full of lessons for anyone looking for a financial advisor. These questions can help you spot red flags.

Do you know your advisors credentials?

It’s clear that anyone who invested with Madoff did what many of us do: they relied on the recommendations of friends, family, or financial experts. They didn’t do their due diligence and check Madoff’s credentials.

So let’s start there. It’s easy to check credentials for investment advisers (regulators use adviser with an ‘e’) using BrokerCheck from the Financial Industry Regulatory Authority, Inc. (FINRA). But there are more red flags that Madoff’s victims may have seen and ignored. Is your advisor focused on returns or your goals?

Do you understand risk vs return?

Many people search out the best investment returns they can find without considering risk. This is a mistake. Modern finance works on the premise that risk and return are related. Greater returns mean greater risk. In Madoff’s case, friends heard from other friends about his legendary returns, and no one mentioned risk or loss. That tended to be the basis for why people invested with him.

Remember: there is no crystal ball to help you profit off the stock market. And just because you hear about a financial advisor through a religious or social connection doesn’t mean you can trust him.

Do you know what you own?

If you don’t understand how your advisor is generating returns for you, or what risk he’s taking on, ASK. I often wonder if any of Madoff’s clients took him to lunch and said, “Bernie, how do you do it? My poor friends are experiencing big ups and downs in the market while I keep getting 9% per year.”

Did people feel that they had an advisor with inside knowledge? And if so, were they comfortable with the risk of an insider trading lawsuit?

One couple interviewed by CBS said they did ask him about how he kept getting incredible returns, and he threatened to stop working with them. To be clear, Madoff threatened to harm them monetarily just for asking questions.

By refusing to discuss his investment strategy, Madoff denied his investors the ability to assess their risk. What if he invested in drugs or human trafficking? Investors had no way to know or understand what he did with their money.

What should you look for?

Hopefully, your advisor is better than Madoff and tells you, at the very least, what his investment strategy is and what he’s doing with your money. Once you know that, think about whether those investments make sense for you.

Modern finance principles (like the efficient frontier and the efficient markets hypothesis, if you want to look them up) focus more on the combination of things you own than the specific investments themselves. Diversify across different types of companies, different countries, different asset classes (stocks, bonds, etc.) and you’ll be better off.

But it’s about more than just knowing what about your investments. You should also:

  • Know your advisors credentials. Look for an advisor with a fiduciary obligation to you, meaning they have to put your financial interests first. Brokers, who can also be labeled investment advisers, don’t have to do that. Ask anyone advising you if they’re a fiduciary.
  • Have an investment plan. Investments should be used to help you reach a goal, like retirement or even building wealth for your family. Problems tend to arise when people simply focus on the investment. I believe in a low-cost, globally diversified strategy based on Nobel prize winning modern financial principles.
  • Have a financial plan. Investment plans detail how investing can help you reach your goals. But investments are only one part of your overall finances. You should have a diversified financial plan. That can include budgeting, insurance, and more. Start planning early so you won’t be tempted to go for a too good to be true strategy.
  • Accredited investors be extra wary. Investors with $250, 000 or more to invest are considered accredited investors. Accredited investors get access to different investments than less wealthy investors, but this can also open you up to more risk and higher fees. And the disclosure rules may be more relaxed. Be extra vigilant about your investments, and those managing them, if you are an accredited investor.


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