There's a Big Difference Between Reality and Perception

 Napoleon Bonaparte is quoted to have said there is only one step from the sublime to the ridiculous. In a lesser but similar way, I have frequently encountered people who did not realize the moment they would have made abnormal profits on the stock exchange. Worse of all, they later made wrong decisions which ensured they made abnormal losses. Let me explain.

To the financially literate, what I am about to say appears so obvious that it may seem unnecessary and a waste of time and space. Yet millions of people worldwide, through their actions, continue to prove their ignorance and consequently suffer financially when they trade in stocks and stock derivatives.

REALITY FACT 1: You make money on the stock exchange when you sell for more than you bought.

REALITY FACT 2: You make money on the stock exchange when you buy for less than you sold for.

Below are 2 examples of mistaken perception.

MISTAKEN PERCEPTION 1:
Investor buys 1,000 shares at $20 each for a total of $20,000. One year later, the stock price is $45. Mistaken investor calls his friend for a cook-out to celebrate $25,000 he has made on the stock exchange (1,000 shares @ 45 = 45,000 less $20,000 = $25,000).
Two years since the mistaken investor bought the shares, he realizes the share price has dropped to $15. He becomes angry and tells himself he has lost $30,000 ($45,000 less $15,000). In a fit of anger he calls his broker and sells the shares at $15 each for a total of $15,000.

REALITY CHECK 1: The mistaken investor never at any time made $25,000. The only way he could have made the $25,000 was by SELLING the shares at $45 - which he did not do. Therefore, there was no reason for a celebration cook out.
REALITY CHECK 2: The mistaken investor made a loss of $5,000, not $30,000. ($15,000 less $20,000= $5,000 loss) Therefore his anger was unnecessarily 6 times worse.
REALITY CHECK 3: If he had not sold the shares at $15 each and instead held on to them, he would NOT HAVE MADE A LOSS. Profits and losses are only made when shares are bought and sold.



How Would You Protect Yourself With This Knowledge?

If you understand that money is made or lost when and only when a real transaction takes place, you can protect yourself from Madoff-Stanford like financial scams.

When you get a statement from your Madoff-Stanford afiliated broker with unusually high returns, it is very tempting to say, "let all the money stay there so that I can continue to receive long account statements with big figures". Today you know better. You will constantly sell off the shares that reflect the significant increase in value and keep the profits in real money - in your hands.

Therefore, for as long as the scam exists you will continuously profit and hopefully re-coup your initial investment. When the scam begins to fall apart, you will be among the first to know because you will start to receive long explanations instead of real hard cash in your hands.

At this juncture you need to do two things immediately. Request in writing an immediate withdrawal of 100% of your funds from all your investment accounts. If you do not get 100% of your funds, contact law enforcement agencies for direction on the next steps.

Greed, Fear and Despair In December 2008 and early 2009, the Bernard Madoff investment scam was all the rave in the finance news. Madoff had managed to pull off the largest ponzi pyramid scheme estimated at $64 billion by federal prosecutors. In February 2009, R Allen Stanford appeared in the news on allegations of operating an $8 billion ponzi pyramid scheme that scammed 50,000 customers.

Do you wonder how Madoff and Stanford managed to pull such major stunts in full view of regulators and law enforcement agencies? Do you expect people to learn something about finance and investing from these saddening and disastrous sagas?

Emotion 1: Greed - Our selfish and excessive desire to acquire great wealth in the shortest time and with the least effort, sooner or later lands our hard earned cash into the merciless conniving schemes of financial scam artists.

Emotion 2: Fear - When we are part of a large crowd, our irrational apprehension compels us to act in uniformity and utter disregard for due diligence. Fear clouds our judgement and we suffer from paralysis of the will. We lie quiet and defenceless - holding in our hands cheap pieces of paper with large numbers. Oblivious to the fact that a scam artist withdrew real dollars from our bank accounts and is revelling and squandering our retirement dollars on some paradise island and a 7-million-dollar penthouse. Those statements you regard so highly as strictly confidential may as well be blank and posted at the local mall's noticeboard. They represent nothing and it doesn't matter who reads them.

Emotion 3: Despair - It is easy to feel powerless and lose hope when your life savings are gone with the wind. It is disheartening for a financial calamity to strike too late in life when time has taken toll on your earning capacity and physical ability. Yet it is not right to let the scammer take your life too. There were news about people ending their lives when details of the Madoff scam emerged. Please do not ever consider taking that route. There is more to life than money. Most often the things that bring eternal memories, profound meaning and deep joy are not based on monetary value. Love, Friendship, Family and God may provide you with a myriad reasons to live and enjoy another day.

How Can You Avoid Financial Scam Artists? 1) Asset Allocation and Portfolio Re-balancing:
Asset allocation simply means that you should not put all your eggs in one basket. Consider having near cash accounts e.g. FDIC/NCIS insured money market accounts, real estate, luxury collectibles, commodities, stocks and bonds. In the same light, do not invest all your money with one broker.
Re-balancing means that periodically e.g. every year, you will review your investment portfolio and adjust your investment in the various asset classes so as to maintain a pre-determined mix that is appropriate to your strategy. For example you may determine that 10% of your wealth should be cash, 60% real estate, 20% stocks and 10% other. If next January you review the value of your assets and realize that stocks are 30% and real estate is 50%, you will re-balance your portfolio by selling 10% of stock and investing it in real estate. This way, you will maintain the 10%-cash, 60%-real estate. 20%-stock and 10% other mix.
Most of the people who are devastated by financial scams invest almost all of their money in a single asset class.

2) Act a little strange
Someone once said that if you see multitudes of people going in one direction and a small group of mad people going in the opposite direction, just know they are journalists.
As a general rule of thumb, if you see everyone including your hairdresser and mechanic giving you the same investment advice, just know it is time to do the opposite.
When everyone is rushing to invest with Madoff and Stanford, then it is time to sell and hold on to your real dollars. When everyone if shouting from roof tops that real estate is the best and fastest growing sector then consider selling because the peak is nigh and a depression is looming. When everyone is grumbling that this is the worst real estate market and house values are plummeting, then consider buying.