After The Madoff-Ponzi, The Lesson’s Clear

Everyone’s scrambling… House subcommittee chairman Paul Kanjo wants to launch a government investigation. Outgoing SEC Chairman Chris Cox is “gravely concerned by the apparent multiple failures” of the SEC. He too, wants to get to the bottom of this.

And of course, House Financial Services Committee chairman Barney Frank, whose regulatory urgings did a masterful job ensuring Fannie Mae (FNM) and Freddie Mac (FRE) didn’t fail, wants to introduce even more legislation.

He’s trying to require hedge funds and investment managers open up their books. But it’s useless. Everyone’s trying to find a complex solution to “what went wrong?” and how some of the biggest investors lost so much - when a simple answer suffices.

Investors simply violated two of our pillars of investing - asset allocation and position sizing.

If you don’t invest too much (position size) in any one opportunity and spread your investments around widely (asset allocate), it’s impossible to be wiped out in one fell swoop. Yes, protection is that simple.

But even the “smart money” refuses to adhere to these boring, yet effective principles. For instance, Spain’s Banco Santander (STD), the largest euro-zone bank invested a total of $3.1 billion in the Madoff’s Ponzi scheme.

In the aftermath, the lesson’s simple. Asset allocate, don’t regulate. Because another day will bring another con man just as smooth talking and connected enough to be plausible as Bernie Madoff. And no matter how many protections we bake into the system, financial “innovation” will always outpace regulation.

In other words, for true protection look in the mirror. A little discipline (asset allocating and position sizing) can go a long way in securing your hard earned capital.

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