Chuck Jaffe: Recognizing Investment Hogwash

Chuck Jaffe joins Coach Pete and Peter Richon to discuss investment claims, scams, and the questions investors should ask. This January 2012 interview explores how to examine an investment strategy rather than accepting a promise at face value. Call 800-661-7383 or text PLAN to 600-700. Transcript Automatically transcribed from this episode; timestamps are approximate. 00:00 In this FinancialSafari.com interview from late January 2012, Peter Rashan and Coach Pete interview CNBC finance writer and commentator Chuck Jaffe. This week on the program, we have a very special guest from CNBC. He is finance writer and commentator Chuck Jaffe, and he's going to be talking with us about a very important topic when it comes to keeping your money safe. Friends, you want to avoid being ripped off scams of any type. Chuck is here to comment and discuss with us how to avoid dealing with the next Bernie Madoff. Chuck, welcome in. Thanks for having me, coach. Yeah, well, hey, let's talk about this article. Did people not learn from Bernie Madoff? They didn't learn from the mistakes of the past? Well, I think that that's exactly the problem. I think that people 00:46 basically learn nothing from Bernie Madoff in terms of what should have come out of it for the average person, which is that, you know, you get through an event like that, a horrific event like that, and it's out in the headlines. And now we've passed the three-year anniversary, so now we're sort of telling the story in some very good books. But the average investor is not reading them. And if you take a look at what's happening, you're seeing a ton of Ponzi schemes. What was unusual about Madoff's Ponzi scheme was how long it lasted and how big it got. But the odds are that the average guy is much more likely to be taken in by somebody who goes rogue in his own local community. And we're seeing more and more reports of that kind of activity. There are more complaints being filed, and it just looks like nobody's figured it out. We call that affinity theft a lot of times when people come through a community, a church group, 01:32 or a civic group, and prey on everybody and show some good returns, so then people put more money in. And it doesn't end good a lot of times, does it? Well, and that's what Bernie Madoff did as well. You know, the problem becomes that people drop their guard. You think, I know this guy from church or the country club or wherever, and as a result, you don't do your due diligence. You know, you talked about my book on mutual funds, the actual truth. I've also written two books on choosing financial advisors, and the big problem is that people will go to a cocktail party, and they'll bump into a financial advisor, and they'll think, oh, Providence has smiled upon me. You know, it brought me this person at the same party who knows how to invest right at the time when I've been looking for it. And they drop their guard, they don't do background checks, and suddenly you're in there for all the wrong reasons. Let's talk about the five questions that people should ask every single advisor or themselves before 02:21 they ever put money with somebody. Okay, well, first things first, you want to make sure that as you're looking at everything, you ask a ton of questions. Before anybody has your money, if they're not willing to sit down and answer your questions before they've got your money, think about how they're going to be after they've got your money. So while these are five to sort of avoid being ripped off in a Ponzi scheme type of thing, I would advise many, many more questions. That's what my books are about when it comes to, say, choosing a financial advisor. But let's start with how and why does this investment strategy work? You're being told you're getting either astronomical returns or, in the case of Madoff, like ultra-consistent returns. But whatever you're being offered, you want to know the theory behind the investment. Because fundamentally, the best investment strategies are not much more complicated 03:08 than buy low, sell high. You're being told that something works, ask why. And if the answer is, well, because it does, then you know you've got investment hogwash. And I'd like to point out, there's a bunch of theories that come out pretty interesting, where years ago, it was like the guys at the Motley Fool had their Foolish Four theory, and the supporters were all like, look at how well this works. And guys like me kept asking, why? And their response is, well, it does. That's why the theory falls apart. Likewise, there was a theory a couple years ago about you wanted to invest in four stocks that were the lowest yielders, or four mutual funds that were the lowest yielders, but had high returns. I can't remember the exact theory. But the thing was, it was four. And I asked them, well, why four? Because that's where the number works. And I'm like, that doesn't make 03:54 any sense. That just means that if you tried it with three, it didn't work. And you tried it with five, it didn't work. If you tried it with six, it didn't work. But you threw up one number, and it happened to show that it could have worked this way. That's not an answer. So you always want to get an answer for how and why does the strategy work? It's like three out of four dentists recommend Trident or whatever. Back in the day, they had 25 tables of four dentists, and they found one table that had three out of four that agreed that Trident was a good gum. Exactly. That's exactly what you want to, you know, you need to know. Now, the second side of this, the second question is, why does this investment deliver returns that are either bigger or more consistent than what I can find elsewhere? Right. I've talked to plenty of folks who are made-off victims, and they'll say, well, you know, his strategy was this split-strike conversion strategy. Now, for starters, this is a very difficult strategy to explain, but the secondary side is, which is why 04:41 nobody understood it. None of the average folks understood it. But the second side of this is that if you did the real research and said, well, okay, but why is no one else using it? There were one or two other people using it, but they never had made-off consistency. So again, why is something so good? Why is something so attractive? Because I don't care who the good investor is. You know, Warren Buffett has had bad years. Any great investor is going to have times where, hey, the market's not going up, and they're not going up either. So Chuck, does it make sense to get a second financial opinion? And if so, who do you go to for that kind of information? Well, what you do is you take it to somebody who's got no ties. You always want to have a control group. And what I think the biggest thing is, is that you always want to try to make sure that you have the ability to get a second opinion, 05:30 or at least some basis for comparison. Even if you couldn't go out and get someone else to say, oh, you know, this doesn't seem right to me. You could have gone to somebody else and said, hey, if I gave you my money, how would you manage it? One of the biggest mistakes people make when hiring financial advisors is that they only interview one. And so think about it. You've gotten to a spot in your life where you know you need a money manager or you need a financial advisor. And they come in and they tell you what they're going to do. And boy, they're talking right into the things that made you say you needed help. So they sound great, even if they're terrible. There's pretty much nothing they can do but sound great. So you sign up with them. You've got no basis for comparison. I think people need to go off. And even if you're unable to get a second opinion where, you know, in Madoff's case, while he was talking about split strike conversion, 06:17 we're going to be tough to find a lot of people who could actually talk to you knowledgeably about that. Certainly until the scandal came out, I wouldn't have been able to do it. I would have said, okay, I've heard of it. But, you know, nothing beyond that. Think that you got to go get somebody who says, well, here's what I would do. And then you can sit there and go, okay, I've got this guy that's offering this amazing consistency. Why is nobody else doing it? Why? You know, what's the problem here, et cetera, or what are the red flags? And until you have a basis for comparison, you can't decide what's right for you. There's some that I've seen, and I don't know if they're scams or not, but they're unusual to me. Like, I've seen the Swiss annuity kind of thing out there, where you supposedly send your money to Switzerland and they'll buy an annuity that basically is backed in Swiss dollars instead of American dollars. But they forget to tell you, you have to convert your American dollars from here to Swiss francs, so you lose on that conversion 07:03 to begin with. Then we've got the Iraqi dinars, where you can invest in millions and buy millions of Iraqi dinars for dollars of American dollars there. There's so many things that are unfamiliar to the guys like me there in the financial world. I don't recommend those kind of things. Do you see people doing that? Well, I see people, unfortunately, taking the step. And, you know, the funny thing is, if you ask folks who get taken in by scams like this, what they were looking at, you know, at what point did you suspend reality and this decided it suddenly sounded like a good idea? And they will always tell you that it came back to something where this is what they felt they needed, and this looked like what could deliver it. And the flip side of this is, and we get this all the time, and it doesn't have to be anything that's goofy. You'll get financial advisors who talk to you about portfolio optimization. And, you know, here's how you 07:52 optimize your portfolio. And if you don't have this or that, I talk all the time about my father. My father's 87 years old, and he's never been able to really buy a small cap mutual fund. It means he's not as well diversified as he could be. And so anytime somebody would look at his portfolio, you know, you don't have small caps. You should have this. It'll diversify you better. Well, the truth is, the man is set for life, and he sleeps well at night. If you put in the small cap fund, well, he'd still be set for life. Might be a little bit better. Might not be as good. That's a performance thing that you can't really tell, but he'd be nervous. You know, I get it. The portfolio might not be optimal without the small caps, but it is right for him. And I think that's where a lot of people go wrong. They're looking at something going, well, I need to get this kind of return. Here's something that can do it, or what they want, rather than what they can get 08:40 elsewhere, or what could deliver, or how well they could live, or how comfortable they'd be with a half a percent less. That's a lot safer. Is it more important to get a real good return, or is it more important to have that income you never have to worry about? To me, it's most important to be able to sleep at night. And I think that that's what people forget. I mean, if you get to the point where you can look out and your days are numbered, and you know, you've got some disease, or you're getting old, or whatever it might be, let me tell you what question you're not going to ask. You are not going to ask, hey, what'd the Dow do today? Okay? It's just not that important to you. And I think that the most important thing for most people is, what can I do to create the safety net and the security that's going to allow me to go out and live life? Money is a tool. If money is the 09:26 end, you're missing something. If you're sitting here going, you know, it happens all the time where people say, ah, you know, my goal is to leave a million dollars to my kids. So they get to where their portfolio is valued at a million dollars, or where their net worth is a million dollars. And now they are the poorest people on earth. Because if they lose so much as a dollar, they fall behind their goal, right? So now they can't spend anything, they can't do anything, they can't go on a vacation. You've worked your entire life to a mass of a million dollars, and now you can't spend anything. And it happens all the time, and it's the wrong attitude about money. And unfortunately, when people have the wrong attitude about money, what tends to happen is you're more vulnerable to scams. Well, that's definitely right, Chuck. As the population matures and gets older, I think safety issues become really, really important. Your number five question to me is probably one of the most important ones, and would have kept a lot of people out of the line of fire 10:14 if they would have asked it of Bernie Madoff. And this one is, of course, who do I write the check to? Well, actually, I disagree. In the Madoff case, his check was a legitimate broker-dealer. That's part of the issue. Blight, who was up here in Boston, who actually owned a radio station where I at one point had a show. And Brad made his money the old-fashioned way. He stole it from people. But the truth is, he was a financial advisor. And I know plenty of people who wish he was still their financial advisor. It became very simple. If you wrote the check to his firm, allocation plus asset management, your money was gone. If you wrote the check to the custodian for your funds, he managed your money. He was a very savvy money manager. So it's pretty simple. 11:01 If you wrote it to the right people, he couldn't steal your money. Well, I definitely agree there, Chuck. And you also want to do that with a major company that has a profile and a name, not some guy sitting on the street corner just because he put up a sign, correct? But let's remember that Bernie Madoff did have the profile. Oh, yeah, he did. That's my point. Madoff was a legitimate broker-dealer who at one point had been one of the highest-ranking folks on NASDAQ. And it actually brings up a great point, which is you can protect yourself in a lot of ways. There is one thing you cannot protect yourself from. You cannot protect yourself from somebody going rogue on your watch. In other words, if they've got problems that show up in their background checks or whatever, well, you can spot those if you do background checks on an advisor. You can get a look and take a look and protect yourself. But most Ponzi schemes start 11:51 where the person gets into some measure of personal trouble and then says, well, okay, I've got this money. I can actually access this money. I'll sort of take it out, make myself a short-term loan, because I know I'll be able to get it back and put it back in. And then, of course, what happens is they can't put it back in. It gets worse and worse and worse. And now they go from doing what they were doing to managing this fraud. Okay. The problem is this. If they did everything right, they don't show up in any way that you can find them. And the minute that they go bad, if they're doing all the things to run their Ponzi scheme, you're already in it by the time you find out. That's the problem. It's why you have to do everything up front to try to make sure. You know, Bernie Madoff says the same thing. If you've read any of the books, and my friend Diana Enriquez from the New York Times wrote a terrific book called The Wizard of Lies on the Madoff story, and she's the one journalist who Madoff was really responding to, you know, 12:40 he basically says, I ran a legitimate business. And then at a certain point, which seems to be around 1992, I sort of took from it to try to fix some problems I had gotten into. There's nothing you can do if the guy goes bad on your watch, other than trying to make sure your statements add up and making sure that you're still following up with due diligence and that your statements make sense, et cetera. Folks, his name is Chuck Jaffe. It's a fascinating article, The Five Questions to Avoid the Next Madoff. Everyone who's listening right now, you need to read this article. You can get it online at MarketWatch, or we have copies here in the office. He's also got a great book, The Lifetime Guide to Mutual Funds and Owner's Manual. Chuck, thanks for your time today. Thanks for having me, guys. Thank you so much for listening to this interview on The Financial Safari. Remember, folks, if you have any 13:26 questions about this interview or your financial situation, you can email the team from The Financial Safari at comments at FinancialSafari.com.