There’s a joke going around Wall Street trading desks that goes like this:
Trader #1: Did you know there are two sides to a hedge fund’s balance sheet?
Trader #2: Sure, the left and the right.
Trader #1: Yeah, but on the left side there’s nothing right, and on the right side there’s nothing left.
With fund manager-gone bad Bernard Madoff in the news this week, the joke, which I bet has been around a while, really hits home.
Madoff’s hedge fund, which for years had produced consistent double-digit returns, collapsed this month under the weight of its own hubris, bringing a “who’s-who” of elite American individuals and institutions down with it.
Hey, even billionaires are not immune to common money mistakes. But a toxic brew of greed and financial negligence took down some pretty big fish, including The Royal Bank of Scotland, Nomura Holdings, Steven Spielberg’s Wunderkinder Foundation and The Palm Beach Country Club, among others.
They should have known better, but Madoff’s investors lost way more than they should. Why? Because they failed to stick to one of the most important rules in investing – they did not diversify their money. Like the Enron employees who lost their life savings a few years back, plowing all their assets into the failing energy giant, the lesson is the same. Whether you've got $10 million in a hedge fund, or $10,000 in a 401(k), reducing the risk of catastrophe is only a matter of spreading your assets around.Sure, other factors came into play to spoil the Madoff party. Lack of transparency, lack of accurate, solid financial statements form third-party auditors, and a questionable custody arrangement that had Madoff providing its own paperwork as proof of trades, all fed the beast. But those are oversight problems and the average investors likely wouldn’t know enough to look. But even the most novice investors has to know enough not to keep all of his or her money in one place.