By: Larry MacDonald

The tide went out in 2008 and Bernard Madoff was found to be swimming without a bathing suit. His investment firm collapsed this month, being “basically, a giant Ponzi scheme.” This video on YouTube is quite amusing – it shows Madoff in better times, explaining his investment approach to a room full of people.

The lesson here is that you can never be too skeptical as an investor, especially when it comes to choosing and using an advisor. If something seems to be good to be true, it usually is. Everything must be challenged. And I mean everything.

Most of all don’t put all your eggs with one adviser! Spread them around. Or join the do-it-yourself brigade, which doesn’t take much work if you follow the Couch Potato Portfolio or One-Minute Portfolio approaches.

I personally prefer to do it myself. I likely would have even turned Warren Buffett down when he was soliciting investors for his investment partnerships in the late 1950s and 1960s. Here are some snippets on the legend’s modus operandi from Roger Lowenstein’s Buffett: The Making of an American Capitalist:

“He warned [investors in his investment partnerships] that he would disclose nothing about where their money was invested. He would give them a yearly summary of results, nothing more. Also, he would be ‘open for business’ only one day a year. On December 31, his investors could add or withdraw capital.”

“One time a partner barged into the reception area … intent on finding out where his money was invested. Buffett … told his secretary he was busy. She returned in a moment and said the man insisted on seeing him. He disappeared for a minute and then told his secretary, ‘Price that guy out [of the partnership] ‘…he added, ‘They know my rules. I’ll report to them once a year.”

Buffett’s partnerships were reporting out-of-this-world returns. During his first ten years, from 1957 to 1967, there were four years with market losses ranging from 6.3% to 15.1% but Buffett’s partnership posted gains in all four, ranging from 10.4% to 22.8%. His total return over the period was 1,156%, nearly ten times the gain in the Dow Jones average of 122.9%.

I’m not saying Buffett established his reputation by running a secret Ponzi scheme. He obviously is a diligent and brilliant stock picker and could have pulled it off. But if I had been at one of Buffett’s pitches for investors, I would not likely have joined. To me, the lack of disclosure, restricted liquidity, one-man operation, and a track record “too good to be true” would have been warning signs of the potential for a Ponzi scheme.

Of course, I would have missed out on becoming wealthy alongside Buffett – successful Ponzi scheme or not. It seems you are damned if you do and damned if you don’t when it comes to picking advisors. You can never tell beforehand. I’m happy to do it myself.