Don’t get me wrong. Madoff himself is a despicable person. Over a twenty-year period, he created the world’s biggest Ponzi scheme worth an estimated $65 billion. Hundreds of individuals, retirees, and charities were hurt or destroyed by Madoff’s deception.

He deserved to get the maximum penalty (150 years).

Nevertheless, I look at all the positive side effects of the Madoff scandal. Here are the three most valuable lessons we can learn from the biggest crime on Wall Street in a hundred years.

Investigate before you invest

Millions have now learned a powerful investing lesson. Don’t blindly turn your hard-earned funds over to a money manager just because he promises great returns year in and year out. Be a skeptic about money managers who insist they can beat the market all the time. Make sure the manager has an independent and reliable auditor. Check the monthly statements to make sure there’s no funny business going on.

“Due diligence” finally means something again when it comes to investing.

A corollary is: Manage your own money as much as possible. Use a discount broker and select your own stocks to buy and sell. Get educated by reading books, attending seminars, subscribing to independent newsletters, and asking a lot of questions.

Take responsibility for your actions; don’t blame others for your mistakes.

If you are still uncomfortable managing your own funds, consider investing in publicly traded mutual funds with good track records that you can value daily in the newspaper or online.

Diversify, Diversify, Diversify

I really have little sympathy with individuals or charities that were wiped out by Madoff’s shenanigans. Only the greedy or stupid would invest their entire fortune or foundation’s whole endowment in a single investment.

It’s time to return to fundamentals, specifically, the “prudent man” rule that used to carry some weight on Wall Street and the New York media.

Always diversify so that no single investment can destroy your financial independence.

There is a great deal of virtue in the old proverb, “Don’t put all your eggs in one basket.” From time to time, you hear some guru suggest a modern alternative: ”Put all your eggs in one basket -and watch that basket!”

In most cases, it’s a recipe for disaster.

Sure, most entrepreneurs have made it big by concentrating in one particular business, and when they get rich, the wise ones always diversify their surplus wealth – stocks, bonds, real estate, gold, and collectibles. To invest all their wealth with one money manager or in one brokerage account, that is pure foolishness.

Don’t depend on the government to protect you

Another investing lesson that many seem to blindly ignore is that you’re on your own.

Government lawyers at the Securities and Exchange Commission (SEC) were hopelessly outwitted by Madoff’s firm. Private financial investigator Harry Markopolos warned the SEC three times about Madoff’s fraudulent activities, but Madoff got a clean bill of health from SEC investigators.

Why?

Because the SEC has a penchant to go after the little guys, such as brokers promoting penny stocks, who are usually willing to settle with a small fine, even when they are innocent. SEC agents are judged primarily by “quantitative metrics” – the number of actions it brings and cases it settles.

Last month The New York Times highlighted the incredible story of a small-time California stockbroker who was investigated by the SEC for promoting a small cap stock.

The broker refused to settle because he knew he had acted ethically within the rules, and didn’t want his good name destroyed with a “consent degree.” Even though he was repeatedly exonerated by the courts, he was left a bitter 72-year old man with $1 million in debt defending himself. “They chose me instead of Bernie Madoff,” he said, and it cost him dearly. (See the June 27, New York Times cover story, “Chasing Small Fry, SEC Let Madoff Get Away.”

On a broader more philosophical basis, the existence of the SEC creates a false sense of security, giving the illusion that somehow the public is protected by the government from frauds, deception and scandal. Now we know better.

Investors must live by the rule, “Caveat emptor.” Let the buyer beware.

Source: Three Investing Lessons from Bernie Madoff

Since then, it has been known as “The Friedman Effect.”

It’s important to understand the Friedman Effect because it can have dramatic impact on your investment decisions and your portfolio…

Milton Friedman & The Friedman Effect

Basically, Milton Friedman found that if the Fed switched from tight money to easy money, or vice versa, it would take about six months before you would see any change in the direction of the economy or Wall Street.

The Friedman Effect worked like clockwork during the financial crisis of 2008. In late 2007 and early 2008, the Fed decided to squeeze the money supply and impose a credit crunch on the financial markets to slow down the real estate boom. The Fed got more than it bargained for. Its tight-money policy had a dramatic impact – the real estate market crashed and took the financial markets with it.

The Fed panicked and in September, 2008, Ben Bernanke & Co. reversed course and injected billions of dollars into the marketplace. The Fed’s balance sheet (see chart below) doubled in a few months as the Fed acted aggressively. Among other bold efforts, the Fed bought Treasuries and mortgage-backed securities directly in an effort to stem the tide of a deflationary collapse.

As you can see from the above chart, the Fed’s bank account (Adjusted Monetary Base) doubled in short order in 2008-09.

The Friedman Effect – Pinpointing The First Signs of Recovery

According to the Friedman Effect, that means the first signs of a recovery and stock market rally would occur six months later. Sure enough, in March, 2009, Wall Street bottomed out and roared ahead in one of the strongest rallies in Wall Street history. The S&P 500 Index has climbed an incredible 34% from its lows of March 8.

Moreover, we’ve seen sure signs of stabilization in the financial markets and the economy. The Libor rate – the interest rate banks charge each other to borrow short term – has fallen sharply, an indicator that the financial crisis is ending.

Many economic indicators have also turned positive. On Thursday, the Labor Department announced that the total number of people filing for unemployment insurance fell by 148,000 to nearly 6.7 million in the week ending June 6. That was the largest drop in more than seven years, and snapped a streak of 19 straight record-highs.

The best overall indicator of a possible recovery is the U.S. Index of Leading Indicators published monthly by the Conference Board, a private research group based in New York. The Ten Leading Indicators are designed to forecast the economy in the next three to six months. Most of the indicators are business related, such as new orders for capital goods, building permits and unemployment claims – and, I might add, the stock market and real money supply growth. The Conference Board also surveys the leading economic indicators for 10 other countries around the world.

The Board reported that the U.S. Leading Indicators fell sharply over the past year, and finally bottomed out – in March of this year! The leading indicators have now risen two months in a row. And on Thursday, the index rose 1.2%, the biggest gain since March 2004.

• In short, the good news is that the U.S. economy is slowly but surely on the road to recovery.
• The bad news is that the Fed has apparently decided to step on the brakes again, reversing course in its monetary policy. The days of quantitative easing are apparently over. As the graph above indicates, the Fed has stopped adding to its balance sheet – the adjusted monetary base has stopped growing.

The broader-based money supply (M2) was growing at double-digit rates until a few months ago. Now’s it’s growing at only 2% or less.

This tight money policy could spell trouble down the road if it continues. The stock market will probably continue to push higher for now, due to the lag time in the Friedman Effect. The Dow might even reach 10,000 by the end of this year. But if the Fed maintains this new tight money policy, we could be in for another rough period and a return of the bear market.

Source: The Friedman Effect: Is Another Bear Market Around the Corner?

Here are four tightly regulated stocks Mark recommends that are selling at “incredible bargains. ”

The U.S. financial system is a mess – according to the World Economic Forum, the United States ranks 40th among banking systems around the world. Without federal bailouts, the two largest banks in the country, Citibank (NYSE: C) and Bank of America (NYSE: BAC), would be in bankruptcy, and the good ol’ USA would be headed for the Greater Depression, as my friend Doug Casey likes to call it.

But you’ll never guess where the world’s No. 1 banking system is. No, it’s not fabled Switzerland nor booming Hong Kong.

While the central banks around the world are desperately trying to stem the flow of red ink, this country’s red is emblazoned on its iconic mounted police force.

It’s right next door: Canada. The land of hockey and moose has the world’s soundest banking system. While European and Asian banks are collapsing, Canada stands out as an oasis of financial calm.

Canadian Banks Receive Highest Rankings

According to the Global Competitiveness Report, Canadian banks received the highest ranking, 6.8, out of a possible 7.0 (healthy, with sound balance sheets). The lowest ranking of 1 means insolvent and possible government bailout.

Canada’s stock has been rising quietly – the Canadians are known for their modesty and self-restraint – as American financiers and media are astonished to find that their northern neighbors have somehow avoided the subprime lending scandal and the housing market mess.

What’s Canada’s secret? With the exception of oil-rich Alberta, Canada did not have a strong construction surge as the United States did during the boom years. And mortgage interest is not tax deductible in Canada.

Canadian banks are national in scope; the top five banks have branches in all 10 Canadian provinces, making them less susceptible to downturns. They have large numbers of loyal depositors and a more solid base of capital. They are more tightly regulated than their U.S. counterparts, more liquid and less leveraged.

Canadian Banks – 4 of The Top 10 Largest North American Banks

Among the top 10 largest banks in North America, 4 are Canadian banks:

• Royal Bank of Canada (NYSE: RY),
• Bank of Nova Scotia (NYSE: BNS),
• Bank of Montreal (NYSE: BMO),
• and Toronto Dominion (NYSE: TD), which bought Commerce Bank last year.

Canadian bank executives don’t have to be excoriated by Parliament before taking a pay cut. The CEOs of Canada’s three-largest banks have all voluntarily cut their own pay in response to the global economic crisis.

Canada has its share of problems – being linked to commodity prices – but financially it’s done a better job than its southern neighbor. While the Bush administration ran up massive deficits year after year, Canadian officials finally pushed through a stimulus package that resulted in the government’s first deficit in a decade!

Right now, the Canadian banks are selling at incredible bargains. With operating margins exceeding 30%, and dividend yields between 6% and 8%, Canadian banks are selling at only around eight times earnings. Bank of Montreal is my favorite – it’s selling for only six times this year’s expected earnings and is yielding 10%.

During a crisis, the good investments get hit like the bad ones. But when the markets recover, the good bank stocks will skyrocket, especially those across the border.

Source: Canadian Banks: An Oasis of Financial Calm

This from Investment U:

“Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist.” ~John Maynard Keynes, 1936

When it comes to the best strategy to use during a treacherous bear market, I turn to advice from my favorite guru. The British economist, John Maynard Keynes (1883-1946), made a ton of money during the Great Depression.

It was he who turned the world upside down in the late 1930s when he advocated that the government should counter the Depression by deliberately cutting interest rates, inflating the money supply, and run huge deficits. And during this year’s financial panic, Keynes (his name rhymes with “brains”) is back in vogue.

Today, both Republicans (George Bush) and Democrats (Barack Obama) are joining the Keynesian bandwagon in favor of bailouts, injecting liquidity in the markets, and cutting interest rates. Not surprisingly, this year the Nobel Prize in economics went to Paul Krugman, an outspoken “big government” Keynesian.

As a free-market economist, I am not a big fan of Keynesian prescriptions of inflation and progressive taxation as a cure for depression. I prefer tax cuts, privatization and a stable monetary policy.

While the Keynesian policies of reinflation and deficit spending may avert another Great Depression, it threatens to reignite price inflation and another dollar crisis down the road.

Making Money With John Maynard Keynes

But when it comes to making money, nobody can beat John Maynard Keynes. In 1927, he was appointed manager of the “Chest Fund” at King’s College in Cambridge. As the chart shows below, he was extremely successful as a money manager during a time of unprecedented deflation, depression, bear markets and world war. His fund was up an average annualized return of 9.1% compared to -1% of UK stocks.

Chest Fund Performance 1927 to 1946

John Maynard Keynes’s investment strategy is, in many respects, similar to Warren Buffett’s investment strategy. And even he is impressed. In his 1991 shareholder’s report, Buffett has acknowledged Keynes’s influence on him. Keynes was a man “whose brilliance as a practicing investor matched his brilliance in thought.”

John Maynard Keynes’s Contrarian Investment Strategy

How did John Maynard Keynes achieve such a remarkable success? Years later, he revealed his technique: “My central principle of investment is to go contrary to general opinion, on the ground that, if everyone is agreed about its merits, the investment is inevitably too dear and therefore unattractive.”

In 1933, at the depth of the Great Depression, Keynes took a contrarian position by acquiring the preferred shares of big-utility holding companies in the United States. “They are now hopelessly out of favor with American investors and deeply depressed below their real value,” he said.

He bought, amongst others, National Power & Light Preferred, which he noted yielded 15%, was awash with cash and whose earnings were rising again. He even bought these and other high dividend-paying stocks on margin.

His bet proved to be highly profitable, as his preferred stocks doubled and tripled in value over the next few years. But, I should also emphasize that Keynes was no trader. He bought and held these stocks through thick and thin. He even held good-quality stocks during the 1929-33 bear market, and he was almost wiped out.

Thus, Keynes, like most of us, lost big money during the 1929 crash and subsequent bear market. But surprisingly he didn’t see this as a weakness. He took a positive attitude about bear markets:

“I feel no shame at being found still owning a share when the bottom of the market comes… I would go much further than that. I should say that it is from time to time the duty of a serious investor to accept the depreciation of his holdings with equanimity and without reproaching himself. Any other policy is anti-social, destructive of confidence and incompatible with the working of the economic system. An investor… should be aiming primarily at long-period results, and should be solely judged by these.”

John Maynard Keynes’s Strategy Still Works Today

I recommend John Maynard Keynes’s strategy today: Buy quality companies that are paying consistently high dividends, and hold through thick and thin during the coming years.

If you want to follow Keynes’s idea of buying preferred stocks, consider buying the John Hancock Preferred Income Fund (NYSE:HPI), a closed-end fund that uses a value-oriented approach to invest in preferred stocks and other fixed-income securities rated “investment grade” by Moody’s or S&P.

Currently it pays a monthly income of 15.5 cents a share, for a current yield of 17.5%. It’s selling for an 11.6% discount from its Net Asset Value ($11.86). You could make a substantial capital gain plus the 17.5% dividend yield – almost 30%.

As the economy recovers, and I expect it will in 2009, undervalued companies with strong yields are one of the best ways to land big gains.

Source: John Maynard Keynes: How to Make 30% From an 80-Year-Old Investment Strategy

More from Investment U:

How long does it take your portfolio to recover after a devastating bear market?

It took a little over a year to get even after the stock market crash of October 19, 1987, over four years to get back your money after the treacherous 2000 to 2003 bear market, and more than five years after the 1973 to 1974 debacle.

This time around, with the Dow down 40% from its high of a year ago, it may take three to four years to get back to even. Ouch! If you are waiting for the new administration to bring you back to even, you may have a long wait.

But there’s a way to avoid this entire “catch up” worry: Buy stock indexed annuities. I call it “peace of mind” investing. My wife even has her IRA money invested in them. She hasn’t lost a single penny in her IRA this year because of her indexed annuities. And when the market does recover, she won’t miss out on its gains.

What Are Stock Indexed Annuities?

A stock indexed annuity is a tax-deferred annuity that combines the downside protection similar to a fixed annuity, money market or CD. But unlike these safe money investments, your interest earnings are calculated based on the performance of a stock market index such as the S&P 500, Nasdaq 100, or even European or Asian stock indexes. It enables you to profit from a market recovery.

Of course, you pay a price for eliminating your downside risk.

In exchange for the guarantee, equity indexed annuities typically pay slightly less than the full return of the S&P 500 Index. For example, an indexed annuity using “participation” might offer a “50% participation rate.” This means you’ll earn 50% of the increase of the selected stock market index. If the index is up 20% for the year and your participation is 50%, your return would be 10%.

But in the long run, the total return can be outstanding because in years the market drops, your capital is preserved. You are ahead of the game when the market moves back up.

Below is a hypothetical illustration showing how a stock indexed annuity would have performed compared to the S&P 500.

* S&P 500 return figures does not include dividends nor does the Stock Indexed Annuity.
**Indexed Annuity returns are calculated using monthly averaging, 100% participation, no cap, and a 2.95% spread.

As you can see, the stock indexed annuity would have averaged 8.39% while the S&P 500 only earned 4.40%. That’s mostly because in 2000 to 2002, thanks to the ability to lock in 100% of the gain, the indexed annuity didn’t lose a dime, while the S&P 500 Index got pounced, losing 21.47% in 2001 and 19.97% in 2002.

For over 12 years now I have been directing investors toward no-risk stock indexed annuities created by top insurance companies. Last time I recommended it was September 2007, near the top of the market. But they can be purchased regardless of where Wall Street is.

How Safe Are Stock Indexed Annuities?

One of the questions I often get is how safe are stock index annuities? And my first part of my answer is generally, “As safe as a life insurance policy.” My second answer is, “So make sure you’re investing with the right company.”

Today more than 50 companies offer stock indexed annuities with over 300 different products and dozens of ways to calculate your interest earnings. Make sure to stick with insurance companies that are rated highly by both AM Best and Weiss Services. (A good Weiss rating is vital – earlier this year AM Best rated AIG an A+ company; Weiss rated it a D.)

Most equity-indexed annuities are not registered with the SEC and are regulated under insurance laws. Annuities are backed by the state insurance reserve and multiple re-insurance companies.

So far no fixed or stock indexed annuities have defaulted on what is owed. (Fortunately, AIG was bailed out, so its annuities are safe.) Like any insurance product, it pays to do your research. A company’s history and longevity are some of the best benchmarks you can use.

Countless investors have been sacrificing returns for safety. But with stock indexed annuities, it’s a decision that they shouldn’t have to make.

Source: Stock Indexed Annuities: A Powerful Investment For Getting Back to Even