As the old saying goes:<\/p>\n
\u201cFool me once, shame on you; fool me twice, shame on me\u201d.<\/p>\n
It\u2019s not just a proverb \u2013 it\u2019s a survival strategy. This is especially true for investors. <\/p>\n
When it comes to investing, mistakes aren\u2019t just inevitable \u2013 they can be expensive. But the worst mistake is repeating them.<\/p>\n
Trying to beat the market means taking risks. When you take risks, you\u2019re going to get things wrong. Buffett, Lynch, Templeton, they\u2019ve all found themselves falling victim to this reality; it is unavoidable.<\/p>\n
The best investors make sure they learn from them.<\/p>\n
Fortunately, there\u2019s a (cheaper) shortcut available to investors \u2013 learning from the mistakes of others.<\/p>\n
Frauds, scandals, bankruptcies. There\u2019s no shortage of stories of financial tragedy waiting to be consumed and analysed. So, why not take advantage of it?<\/p>\n
Let\u2019s take a look at three of the biggest of the last 25 years.<\/p>\n
The Bernie Madoff scandal<\/p>\n
Lesson 1: Beware gurus.<\/p>\n
Lesson 2: If it looks too good to be true, it probably is.<\/p>\n
Lesson 3: Trust but verify.<\/p>\n
Bernie Madoff went from the private clubs of Palm Beach, Florida, to federal prison.<\/p>\n
Bernie Madoff was once a high-flying financier and chairman of the NASDAQ stock exchange; he is now more famous for being the mastermind of the world\u2019s largest Ponzi scheme.<\/p>\n
At its core is a story of misplaced trust in a person they believed was an investing guru.<\/p>\n
Notoriously secretive, Madoff refused to engage with those who trusted him with their capital, even becoming abusive if they tried to ask questions.<\/p>\n
As shown below, in the chart of Fairfield Sentry, a hedge fund that invested 95% of its capital with Madoff, shows, the results were good (or so it seemed). So, it worked. Investors left him alone.<\/p>\n
<\/p>\n
The performance of a fund heavily invested in Madoff (Source: The Journal of Derivatives, Fall 2009)<\/p>\n
But, as the saying goes, if it is too good to be true, it probably is.<\/p>\n
Madoff, it seemed, couldn\u2019t put a foot wrong. Even continuing to generate positive returns during the collapse of the Dot-com bubble, when everyone else lost a fortune.<\/p>\n
Not everyone just accepted Madoff\u2019s figures. At least one fund manager, sceptical of the performance, took the time to run the numbers and simulate Madoff\u2019s strategy. The results clearly showed that such performance was impossible.<\/p>\n
The SEC and FBI would soon be made aware of this and would be used to convict him.<\/p>\n
To summarise, beware gurus, especially if they refuse to shed any light on how they achieve their results. Don\u2019t let greed blind you to incredible claims, even (or perhaps especially) if they are delivered in a way that looks official.\u00a0<\/p>\n
Finally, although a lot of trust is involved in investing, it\u2019s also important that you try to verify, if not try and falsify, claims being made, especially if those claims are big ones.<\/p>\n
Suggested watching: Madoff: The Monster of Wall Street on Netflix
\nEnron<\/p>\n
Lesson 1: Intelligence can be an asset or a liability.<\/p>\n
Lesson 2: Culture matters!<\/p>\n
Lesson 3: Although bad numbers can be hidden, they can\u2019t disappear.<\/p>\n
Outside of Madoff, Enron is arguably the most infamous scandal of the twentieth century.<\/p>\n
Once a boring energy distribution business, it would soon reinvent itself as a flashy, fast-growing energy trader. That is, before it all came crashing down under the weight of dodgy accounting.<\/p>\n
Enron provided another example of misplaced trust. This time, not in gurus, but genius.<\/p>\n
Enron\u2019s management was considered some of the most intelligent business minds in the world. Which was arguably correct; however, genius can be used for both good and bad purposes, which is what happened here and arguably why it took so long for it all to go pear-shaped.<\/p>\n
It also highlights the importance of culture.<\/p>\n
The culture inside Enron was hyper-aggressive. It was also one almost singularly focused on keeping the share price going up.<\/p>\n
This creates a volatile situation where fraud, where there was not just an opportunity for it to happen, but the incentive to do so and the ability to rationalise it \u2013 known as the fraud triangle.<\/p>\n
The Enron scandal also showed that, while bad numbers can be hidden, they can\u2019t disappear. <\/p>\n
Every time Enron shifted negative figures off its financial statements, it left something behind \u2013 such as a declining return on equity, which was used by famed short seller Jim Chanos to spot that something was going wrong and profit from the company\u2019s collapse.<\/p>\n
Enron was a story of extremely smart people not realising they were doing dumb things, which was allowed because they created a culture that allowed it to happen. But by digging under the surface and questioning the picture being drawn by management, some were able to spot what was really going on and either avoid the blow-up or, as in the case of Chanos, profit from it.<\/p>\n
Suggested reading: The Smartest Guys in the Room by Bethany McLean
\nWirecard<\/p>\n
Lesson 1: A combative attitude to critics is a major red flag.<\/p>\n
Lesson 2: You really don\u2019t know who you are trusting.<\/p>\n
Lesson 3: You can\u2019t absolve responsibility to regulators.<\/p>\n
Wirecard was meant to be Europe\u2019s response to Silicon Valley\u2019s monopoly on high-flying tech companies.<\/p>\n
However, its captivating tale of soaring revenue growth would eventually be proven an illusion, leading to the company\u2019s collapse.<\/p>\n
<\/p>\n
Wirecard’s share price history between 2017 and when it collapsed. (Source: Reuters)<\/p>\n
The most interesting thing is that Wirecard\u2019s nefarious activities weren\u2019t even much of a secret. In fact, the Financial Times had been blowing the whistle on the company as many as six years before the company\u2019s collapse, which you can read about\u00a0here<\/a>.<\/p>\n So why did so many people fall for it?<\/p>\n Wirecard took a very combative approach to critics. <\/p>\n They made the market question the motives of those calling out the company. Wirecard were the good guys in this story, fighting a cabal of short sellers and market manipulators.<\/p>\n This is regularly a red flag. A business that is performing well and has nothing to hide doesn\u2019t need to attack critics. Business performance will prove them wrong eventually.<\/p>\n Wirecard also highlights the fact that you really don\u2019t know who you are investing in.<\/p>\n Jan Marselek, Wirecard\u2019s chief operating officer, was seen as a bit of a boy wonder. Today, he is one of Interpol\u2019s most wanted and is alleged to be an asset of Russia\u2019s intelligence services.<\/p>\n Warren Buffett can say that he will only invest in management he trusts. His clout means he gets to meet and get to know these people. <\/p>\n For the average investor, this isn\u2019t the case. Made even harder by the fact that CEOs and other key managers are also very good salespeople. They are easy to trust, even when you shouldn\u2019t.<\/p>\n You also can\u2019t absolve the responsibility of protecting yourself to regulators. You are the only person who is really looking out for you.<\/p>\n Wirecard proved this more than any other story. Germany\u2019s financial market regulator was given all the information they needed to clamp down on Wirecard; instead, they investigated the Financial Times and other whistleblowers for alleged market manipulation.<\/p>\n They would issue an apology, but not for many years.<\/p>\n Wirecard was a captivating tale of technological disruption built on a bed of lies. It lasted for as long as it did as the company managed to silence its critics, partially helped by regulators, and change the narrative.<\/p>\n Don\u2019t fall for it.<\/p>\n Suggested reading: Money Men by Dan McCrum<\/p>\n Never miss an update<\/p>\n