Madoff scandal and stock market problems offer lessons for investors

Colin McLean, Managing Director, SVM Asset Management: The Madoff investment scandal and recent stock market problems offer lessons for all investors.

Volatile markets can make it easy to lose sight of basic principles, yet they are even more important in current turbulent conditions.

Avoid Overconfidence

It is not just that it is human nature to make mistakes - we tend not to be good at actually assessing the chances of being wrong, or where the risks lie. The key to good portfolio management is maintaining similarly sized investment positions. Madoff had become a big bet in many portfolios. One or two disproportionately large investments greatly magnify risks and might actually reflect excessive, but misplaced, confidence.

Analyse Dispassionately

It can be hard to view a share's prospects dispassionately, when so much emotion has already been sunk into buying and holding that stock. Even though some shares exasperate us, we want to keep them long enough to see them recover losses. As a result, most investors hold onto bad shares too long, being unwilling to sell at a loss, and desperately hoping that market values will recover. Studies have shown that it is shares showing losses against purchase cost that actually can have greatest risks.

Be Sceptical

The Madoff affair also highlights what can happen when investors let their guard down piggy-back on others' research. Too late, some now realise the danger of relying on supposed endorsements from famous names. This does apply more widely. Many now regret following the various investment gurus who called the end of the bear market at much higher index levels. It highlights the importance for investors to do their own research, or at least actual check the results and judgement of anyone they rely on.