Bernie Madoff: A Lesson in Diversification

Bernie Madoff recently plead guilty to running a $65 billion dollar Ponzi scheme.  He scammed his investors out of billions of dollars and will likely spend the rest of his natural life in jail.  While most of his victims were indirectly affected, many people trusted him with ALL of their savings and lost everything.

Not putting all your eggs in one basket is a simple concept, but the Madoff case reinforces this principle.  Many people think of diversification as just picking between different asset classes and asset types.  But you also need to consider “paradigm risk” – the risk that the floor will be pulled out from under you and the rules of the game will be changed.  When the US government can pass a bill that taxes 90% of your bonus income, you know the rules of the game are changing.

There’s no real concrete strategy for protecting against paradigm risk.  I would just think of the worst possible thing that could happen to your assets and apply a soft hedge.  Below are some simple examples.

  • Work with more than one financial advisor – Hopefully at least one of them won’t be a Bernie Madoff.
  • Open an offshore account – This will lower your United States risk.
  • Deposit at multiple FDIC insured banks – Banks can fail.  It’s a reality we live in today.
  • Buy a safe and put a portion of your savings there – To those who are used to modern financial systems, this seems somewhat arcane.  But I still think it’s a good idea.  You really won’t know the value of it until you need it.

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