Invest with Bernie Madoff?

What if someone told you that they could guarantee a return of 15% per year on your investment.  Would you believe them? Or more importantly, would you invest your money with that person?  If you answered “no,” then I would believe that you weren’t born yesterday (or just fell off the proverbial turnip truck), and know that such a statement is most likely false.  To clarify, let me explain a few things about investments and guarantees.

Lesson One: There are really only 3-investments that have guarantees (that is, they don’t have any risk to loss of principal).  They are 1) a Certificate of Deposit or CD (insured up to $250,000 by the FDIC); 2) GNMA or Ginnie Mae Bonds—which are guaranteed by the Federal Government; and 3) United States Treasury Bills, Notes, and Bonds.  That’s it folks—just those 3-kinds of investments.  Of course your checking and savings accounts which are backed by the full faith and credit of the U.S. Government at an FDIC or NCUA bank or credit union are also “insured,” but those aren’t considered investments.  Finally, not even Money Market accounts are guaranteed….I repeat, Money Market accounts aren’t guaranteed!

And with the reduced risk of these types of investments comes reduced potential for return.  One year CDs are currently paying less than 1% on average, Treasury Bills are yielding a fraction over 0% for 1, 3, and 6-mo durations, while a 5-year Note is yielding about 1.5% per year.  GNMA or Ginnie Mae Bonds with a 10-year duration are yielding around 2.5% per year. [source: 6/30/2011]

If these lowly returns don’t sound very enticing to you, it’s because they’re not meant to be exciting or attractive.  In fact, when you consider that bonds are currently yielding such low returns, and there’s really only room to go up from here, consider the likely possibility that their prices will depreciate once newer issued bonds are yielding more.  So you’ll be left holding that super low return to maturity, or have to trade it in at a potentially steep discount from what you bought it for.  Enough fixed income talk for now—call me if you want to get technical.

So, what about Bernie Madoff and his sweet returns, a guaranteed investment return of 15%, or even someone’s claim of “no risk” on a real estate investment?  You must understand that none of these investments are guaranteed and/or carry “no risk.”  Because if they really were guaranteed to deliver a terrific yield of 15%, virtually everyone (including institutional investors), would be invested in that investment.  Trust in an investment advisor is something that is earned over time.  Blind trust in an investment that has no history and no ability to insure your principle sounds like a foolish investment to me.