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The table below summarizes some of the most important savings and investment products that you are likely to use during your lifetime financial journey. Note especially the level of risks and returns associated with each asset (with four stars being the highest risk).
Table: Savings and Investment Products
Bank Products | EE/I Bonds | Stocks | Bonds | Mutual Funds | ETFs | Hard Assets Including Real Estate | |
---|---|---|---|---|---|---|---|
Key concept | Low risks mean low returns. | Guaranteed returns are state income tax-free. | Stocks are a great long-term investment. | Bonds are appropriate for those who need current income. | Funds provide diversification and professional management. | ETFs blend the best of stocks and index mutual funds. | Hard assets can be good diversification tools. |
Risk | * | * | *** to **** | * to **** | * to **** | ** to **** | *** to **** |
Return | * | ** | * to **** | * to **** | * to **** | * to **** | * to **** |
Where to buy | Directly from a bank or credit union. | Directly at a bank, credit union, or through the Internet. | Usually in a brokerage account but sometimes in a dividend reinvestment plan. | Almost always in a brokerage account. | Through a financial advisor or directly through a no-load mutual fund through the Internet. | Almost always in a brokerage account. | In local stores, marketplaces, and real estate markets. |
Protection | Depositors are insured through FDIC. | Although not insured, guaranteed by U.S. government. | Not insured; brokerage account has SIPC coverage. | Not insured; brokerage account has SIPC coverage. | Not insured; brokerage account has SIPC coverage. | Not insured; brokerage account has SIPC coverage. | Not insured. |
One thing should stand out from the previous table: Few of the investments that you are likely to use to build wealth provide any type of protection against losses linked with fluctuations in the markets. Although it is true that the government works daily to help make the investment world safer, only bank and credit union savers have access to direct account insurance.
Federal and state regulators constantly monitor the investment and insurance marketplace for wrongdoing on the part of companies and individuals. Regulations are in place to make sure that a baseline level of safety exists in the event of a firm or system-wide failure that could result in the loss of cash or securities.
Even with FDIC and SIPC insurance in place, you cannot afford to be complacent about your money or investments. It is important to take steps to be aware of possible frauds, misrepresentations, and consumer rip-offs. You can do this by:
Bernie Madoff was one of the most respected and influential people on Wall Street. He ran the worldʼs largest hedge fund, which is a private investment company that caters to the investment needs of wealthy individuals and organizations. Letʼs learn a bit more about hedge funds and Bernie Madoff.
Hedge funds get their name from the investment approaches these firms use to manage client money. Hedge funds pool money from wealthy investors and invest in securities or other types of investments with the goal of obtaining positive returns. Hedge funds, however, tend to be less well-regulated than other managed investment products and services, like mutual funds. Because hedge funds are not highly regulated, hedge funds can only solicit investments from accredited investors. An accredited investor is someone who has:
Madoffʼs firm was so successful that he was able to establish strict standards for those that he would accept as clients. Typically, clients had to have several millions of dollars to invest and be politically and socially connected. Investing with this man was considered a privilege, and people lined up begging to give him their money.
Madoff was able to perpetrate his scheme using the media as a way to promote his investing record. Here are examples of what the financial media reported about Madoff before he was exposed as a fraud.
As you continue your lifetime financial journey you can learn several important things from the Madoff case:
IN CONTEXT
Assume that a fraudster using a classic Ponzi scheme starts with 6 investors and plans to increase the number of new investors by a multiple of 6 every year. In other words, the fraudster plans to take money from 6 people in year one, 36 in year two, 216 in year three, and so on. The fraudsterʼs plan is to use money from later investors to pay off previous investors (plus pocket some money along the way). How many years will it take for the fraudster in this scenario to run out of investors if you consider that the worldʼs population is around
7 billion people?
Here’s the solution:
It will take between 12 and 13 years before the fraudster in this scenario runs out of investors, as the following shows. This is how Ponzi schemes fail. At some point, the number of potential victims drops to zero.
Year Investors 1 6 2 36 3 216 4 1,296 5 7,776 6 46,656 7 279,936 8 1,679,616 9 10,077,696 10 60,466,476 11 362,797,056 12 2,176,782,336 13 13,060,694,016
Source: This content has been adapted from Chapter 8.11 of Introduction to Personal Finance: Beginning Your Financial Journey. Copyright © 2019 John Wiley & Sons, Inc. All rights reserved. Used by arrangement with John Wiley & Sons, Inc.
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