I was chatting with an old college classmate a few weeks ago about the stock market, and he asked me a question I would bet is on countless folks’ minds:
Rather than answer this one myself, I thought I’d hand it off … to Bernie Madoff.
Yup, that’s the same Bernie Madoff who currently is serving a 150-year prison sentence for orchestrating the biggest Ponzi scheme in history and will likely go down as one of Wall Street’s most infamous liars.
But that’s part of what makes his advice worth a listen.
MarketWatch recently interviewed Madoff behind bars, asking about whether the markets are fair and how retail investors can protect themselves from … well, people like him. One thing he said that stood out:
“The individual investor is the last person that has any information. The average investor is coming up against professional financial firms, hedge funds and the professional trader, and it’s easy to be scared out of the market.”
I’ve posited before that fear and distrust are two big reasons coming-of-age adults hesitate to invest. Not only did my generation watch the Great Recession eat up our parents’ life savings, but we also watched Madoff’s scheme come tumbling down … followed more recently by Facebook’s (FB) botched IPO, the Knight Capital (KCG) trading glitch, the JPMorgan Chase (JPM) London Whale losses and the Libor scandal, among others.
Madoff especially, though, is a prime example of why average Americans don’t trust the slick, suited men of Wall Street. When his scam was finally exposed, it made headlines far beyond the finance world. Robert DeNiro will soon portray him in a HBO film, while other features and documentaries have already been made about the now-villain.
Heck, Madoff’s name has even been used in rap lyrics.
All in all, men like Madoff make Wall Street feel not just like a different world, but one you wouldn’t even want to visit. No wonder one of the first questions on soon-to-be-investors’ minds is how to tread carefully into the market waters with “reliable” investments.
But Be Smart
There are no guarantees in the stock market. Just ask Bernie. If you want certainty, he says, leave your money in a savings account or buy bonds. And even those “reliable” strategies have their own shortfalls.
As he put it in the interview, “If you are risk-averse, you should buy municipal bonds or government bonds. But you get 2.5% interest, lower than the inflation rate.” So while you might not lose your money in a huge downturn or Wall Street scam, your money will lose its spending power.
Instead, when asked what the safest place to invest money is, Madoff replied: an index fund — essentially, a fund whose performance is tied to an index, such as the S&P 500. He explained, “There are lower commission rates and more professional management with these types of firms.” He also specifically likes mutual funds because he says they are large enough to protect investors from fraud.
Madoff is hardly a trailblazer here. Numerous experts, including InvestorPlace Editor Jeff Reeves, have been urging investors to opt for index funds for some time now.
In previous articles, Reeves pointed to several reasons why letting the computers play for you can actually be more profitable than stock-picking on your own. For one, even active managers — you know, pros who invest for a living — historically do not beat their benchmark index. In fact, “a whopping 84% of active managers underperformed the market in 2011″ while “more than two-thirds fell short in 2012.”
Index funds are thus a great way to avoid paying an active manager for under underperformance. They also help protect you from fraud, and they can keep you from fooling yourself into thinking you can pick the next hot stock.
For all of his infamous schemes, Bernie Madoff still was an experienced Wall Street mind. But while many lost fortunes listening to him in the past, his advice should be heeded this time around.
After all: What good will lying to investors do him now?
Alyssa Oursler is an Assistant Editor of InvestorPlace.
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