Sounds Too Good to Be True? It Probably Is

While most of us don't live an extreme life, we sure seem to be fascinated by those with extreme lifestyles. So when the Charlie Sheens and Bernie Madoffs of the world operate at a level that's hard to fathom for "normal" people, it's no surprise we're fascinated. But here's the thing: The driving factor behind extreme behavior is that someone or something enables the extreme behavior.

Too often, money drives the enabling.

For instance, remember when Mr. Sheen very publicly went, well, out of control? A concerned friend approached one of Sheen's inner circle about getting him help, only to be told, "We make a lot of money from him. I can't be part of" helping him. How often have we heard a similar justification used when it comes to reckless investing in the markets?

Consider the article that appeared in The New York Times highlighting the first jailhouse interview that Mr. Madoff allowed. What caught many off guard were his assertions that an entire group of supposed experts turned a blind eye to their suspicions of him.

Unsealed court documents could back up his claims. In a lawsuit filed to recover funds, Irving Picard, the trustee representing Madoff victims, claims that as early as 2007 a Citigroup executive analyzing Mr. Madoff's fund concluded that his strategy couldn't generate the published returns.

At JPMorgan Chase, internal documents suggested that senior executives doubted Mr. Madoff's legitimacy more than 18 months before his Ponzi scheme collapsed, but kept doing business with him. Were his actions enabled by people there who benefited directly from his operation?

The everyday investor isn't immune to getting pulled in by their fascination. Wall Street doesn't make sense to most people, so few people asked many questions when supposedly conservative bankers started offering new products to mainstream investors, like derivatives and securities backed by mortgages (often subprime loans). These experts knew better, but many of them were turning a blind eye to the problems they were creating in the name of profits.

Nobody wanted the music to end. And we kept buying the products even as we sensed that no-money-down mortgages made very little financial sense. You, me, and most everyone else struggles to work up the nerve to question things that appear too good to be true and come with a financial benefit.

Just so you don't think the world is populated solely by bad guys, I think it's worth pointing to Carl Icahn's announcement in 2011 that he would return money to outside investors in his hedge fund. There are some other issues that may have been behind his decision, including concerns about increased regulation of hedge funds. Still, Mr. Icahn's decision does seem a marked contrast to what we've previously seen in financial markets, particularly given a statement in his letter explaining the decision: "While it may sound 'corny' to some, the losses that were incurred by investors in our funds in 2008 bothered me a great deal more, in many respects, than my own losses."

Whatever his full motives, Mr. Icahn's actions are a reminder that "too good" opportunities deserve our skepticism. I'm the first to admit that it's very tempting to turn a blind eye to bad market behavior, but we'd be wise to think twice.

If you push them, many investors will admit that they're unclear about the level of risk they're assuming, but their actual behavior may indicate that they think making money in this market requires you to turn off your brain and dance until the music stops. At some point, we have to accept that enabling the bad behavior of others will ultimately hurt us. To pretend that we're immune only makes the fall that much harder.

A version of this post appeared previously at The New York Times.

Carl Richards is a financial planner and the director of investor education for the BAM ALLIANCE, a community of more than 130 independent wealth management firms throughout the United States. Visit Behavior Gap for more of Carl's sketches and writings.

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