Excerpts from Fisher Investments CEO Ken Fisher’s 2009 book, How to Smell a Rat
From Charles Ponzi to Bernie Madoff, financial scams and frauds have been well-documented in recent history. And although only the largest scams are in the collective consciousness, everyday regular Joe's (and Jane's) are being bilked out of their hard-earned dollars, and usually have no problems until the money's disappeared. Fisher Investments' CEO, and company namesake, Ken Fisher, lays out in simple terms, questions to ask and red flags to look out for in his book, "How to Smell a Rat: The Five Signs of Financial Fraud."
Below are a few lessons to be noted, and learned from, about investment frauds and scams:
Scams & Fraud
Scams and scamsters have been around for centuries. Here are a few quotes from Fisher Investments CEO Ken Fisher's How To Smell a Rat:
"Scamster rats tend to be pretty charismatic with pretty, fancy whiskers, claws, and tales instead of tails — but enough frank scrutiny from victims can be their undoing."
"The scandals you read about are sensational size-wise, but these scams go on endlessly on smaller scales in small towns everywhere. These don’t make the papers - maybe not outside their regions - because the scams get outed before getting too big. But victims don’t care if it was a big scam or small - they still lost everything. And even the biggest scams started small, once."
"Bear markets reveal scams, but bear markets don't cause scams."
'Fraud' is defined as: deceit, trickery, sharp practice, or breach of confidence, perpetrates for profit or to gain some unfair or dishonest advantage.* Most issues borne from dealing with "fraudsters" is that they seemed so "honest". Here's what Fisher Investments CEO Ken Fisher has to say about bear market's uncovering frauds:
"Also, investors in general, even in perfectly legit investment vehicles, tend to get fearful and redeem shares during downturns, putting additional pressure on fraudsters."
"The fraudster created the fraud - no one and nothing else - and market volatility uncovered it. A fraudster is never an indictment of any era - he's just an indictment of his own soulless black heart."
Don't Give a Fox the Key to the Henhouse
The first and most important tip in the book is "never give your adviser custody of your assets." It's like inviting a hungry fox into the henhouse, and then saying, "Now don't eat the chickens or the eggs." A good amount of "average Joe/Jane" investors don't understand this concept, and to Ken Fisher, CEO of Fisher Investments, it's the most important key to a healthy investor/adviser relationship. Below are some key quotes from How to Smell a Rat:
"I've studied the recent cases and history's biggest cases, and they all have one thing in common - financial fraud sign number one: The money manager also had custody of the assets."
"You must remain vigilant to protect yourself. Try as regulators and politicians might, there will always be black–hearted thieves and enough folks to victimize who believe big returns without risk are possible."
"A rat has to have access to the cheese. Take away the access, and they probably do no more damage than a Three-Card Monte street hustler. And if you don't give them that access-refuse to hand over decision making - then you are safe."
"You want an account in your name at a big - name, third-party, non-connected custodian who makes you jump through hoops a little bit to confirm you are who you say you are. That shouldn't annoy you - that should give you confidence others won’t be able to get at your money."
"You're just too good to be true…" --Frankie Valli & The Four Season
If it walks like a duck, and sounds like a duck – guess what? It's a duck. The same analogy can be applied to "too good to be true." If it sounds too good to be true, it usually is. Below are a few quotes from the book to further illustrate this point:
"Fraudsters claim not just fake returns, but fake returns that are consistently high, positive, and better than what you could get normally from markets - no matter what stocks, bonds, or other principle securities do."
"Con artists use claims of great, non-volatile, consistently positive returns to ensnare victims and keep them docile. And fake returns help stall detection."
Hazy Makes You Lazy and Crazy
Investing in anything other than a basic savings account usually scares the heck out of an average Joe/Jane. Most novice investors say "I don't understand it—that's why I'm paying you." The deal is this - reputable investment professional relish questions and should be able to explain their methodologies and strategies in old-fashioned, plain English. Below are a few quotes from the book that simply spell this out:
"Rats aren't looking for financial illiterates. They want victims who won't question too hard - either because they're busy, intimidated, or easily distracted by outsized performance claims"
"Ask an adviser, "What's your strategy?" It's not a hard question. Advisers shouldn't demure. They aren't giving away state secrets. I can understand why a manager won't detail exact portfolio holdings to a non-client - doing so could hurt current clients. But there should never be anything secretive about a strategy. You don't give anything away by detailing strategy."
"If the manager can't explain his strategy well, and it sounds like so much mumbo jumbo, look for the exits. It may not mean the manager is a rat. It could mean he doesn't have time for you or doesn't have an adequate service team. Either way, you're better off elsewhere, while remembering that sometimes the return of your money is more important than the intended or stated return on your money."
"I don't care to belong to a club that accepts people like me as members." -- Groucho Marx
When looking at exclusivity and reputations, let's use this easy analogy: Go way back to childhood and, at the sandbox, everyone wants to be the kid with the cool bucket and shovel. If the sandbox only admits kids with the same cool buckets & shovels, that sandbox creates an air of exclusivity. Exclusivity, just for the sake of being exclusive, can lead to making decisions based on emotions - a big no-no when dealing with financial matters. Let's go back to the sandbox again - reputations are also at risk. A newcomer to the box wants to play with the bucket & shovel and the Mommy says, "Share—please." Two scenarios can happen: 1. Bucket-owner child wallops the newcomer with the shovel—they now have a reputation for being a brute, or 2. Bucket-child shares and their reputation will be the "nice" child. Below are a few quotes dealing with exclusivity and reputations:
"Secrecy is the ultimate form of exclusivity. If you're trying to impress the gatekeeper so you can get in, you'll be ultra-sure not to question his tactics too hard - that could cause him to decide against you!"
"Exclusivity might make sense for a social club, but it doesn't for financial advisers. Be suspicious of claims of "exclusivity" from your money manager."
"Reputation is an idle and most false imposition; oft got without merit, and lost without deserving." --Iago, Othello, Act II Scene III
"So don't be too impressed by reputation. It's changeable, isn't measurable, isn't tangible, and is easily influenced by factors having nothing to do with ability. Iago's reputation quote is spot on: Some dishonorable con men will buy good reputations via charity and political donations."
Your best advocate is... YOU!
Simply put, if you do your own due diligence, you may likely limit potential issues down the road. Below are a few quotes from Fisher Investments CEO Ken Fisher’s How to Smell a Rat regarding due diligence:
"That regulators didn't catch these swindlers earlier is a pretty good indication that you can't count on them to protect you. Only you can protect you."
"Seek adviser transparency and a standard of disclosure leading to heavy regulatory oversight. By and large, this means a firm registered with the SEC."
"If firms commit to transparency, it's easier for you to fact check. And it allows you to spot weird inconsistencies that, if followed, can be red flags saving you."
"Never pay a big fee to someone to stand between you and your ultimate decision maker."
"Friends are great, but no matter how deep your friendship, or how much you think they know about business or investing, a recommendation from friends is not due diligence."
Fraud Free Finances-It Too Can Be Yours!
Five signs. That's all it takes to arm yourself against scamsters, rats, and fraudsters. The first sign is crucial - never give your money to the decision-maker. Better yet, house your hard-earned dollars at a big name financial custodian, and the chance of the rug being pulled out from under you just decreased dramatically. The other four are important also, but #1 is paramount, and stops most schemes before they start. By using these five guidelines from Fisher Investments CEO Ken Fisher, the average Joe's biggest issue - investing is too complicated and confusing - will be a distant vision in their rearview mirror.
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