“One out of four investors surveyed will write a check without having studied the financial statements of the fund. Nearly one in three will not always run a background check on fund managers; 6% may not even read the prospectus before ever committing money. “Due diligence,” says Stephen McMenamin of the Greenwich Roundtable, “is the art of asking good questions.” It’s also the art of not taking answers on faith.“ Jason Zweig, Dec 13, 2008, WSJ
What do George Carlin and Bernard Madoff have in common? The late comedian immortalized oxymorons, those absurd word pairs like “jumbo shrimp” and “military intelligence.” Mr. Madoff just put the silliest of all financial oxymorons into the spotlight: “sophisticated investor.”The accounts managed by Bernard L. Madoff Investment Securities LLC reported gains of roughly 1% a month like clockwork, with nary a loss, for two decades. Why did that freakishly smooth return not set off alarms among current and prospective investors?Of all people, sophisticated investors like Mr. Madoff’s clients should know that if something sounds too good to be true, then it’s not. But they believed it anyway. Why?
By Jason Zweig, Dec 13, 2008, The Intelligent Investor, WSJ
Madoff emphasized secrecy, lending his investment accounts a mysterious allure and sense of exclusivity. The initial marketing often was in the hands of what one source described as “a macher” (the Yiddish term for a big shot). At the country club or another exclusive rendezvous, the macher would brag, “I’ve got my money invested with Madoff and he’s doing really well.” When his listener expressed interest, the macher would reply, “You can’t get in unless you’re invited…but I can probably get you in.”
Robert Cialdini, a psychology professor at Arizona State University and author of “Influence: Science and Practice,” calls this strategy “a triple-threat combination.” The “murkiness” of a hedge fund, he says, makes investors feel that it is “the inherent domain of people who know more than we do.” This uncertainty leads us to look for social proof: evidence that other people we trust have already decided to invest. And by playing up how exclusive his funds were, Mr. Madoff shifted investors’ fears from the risk that they might lose money to the risk they might lose out on making money.