Bernard Madoff committed the largest financial scam in history. This, you know. You may not know the stunning details of how he did it and managed to get away with it for so many years. That’s why we recommend watching the new four-part docuseries on Netflix. It includes interviews with victims, investigators, and scenes from Madoff’s depositions.

Fifteen years since his 65 billion dollar Ponzi scheme unraveled, there have been several depictions of Madoff, but “Madoff: The Monster of Wall Street” offers new insights worthy of your time.

Did you know that December 11, 2018 marked the 10-year anniversary of the day Bernie Madoff was charged with securities fraud? His colossal $64 billion dollar scheme came crashing down.

While there is certainly nothing to celebrate about the anniversary, there are lessons to learn. Ranking toward the top of our priority list, we should do all we can to prevent history from repeating itself, at least to the same magnitude.

Madoff’s Manipulative Mind Games

One of the telltale signs of Madoff’s malfeasance is easy to describe, but treacherously tricky to catch when it’s happening to you. Madoff was famous (now infamous) for supposedly employing stock options to deliver unwavering returns, year after year after year, no matter what the market was doing.

Think Houdini. When a supposed gentleman with impeccable credentials is masterfully managing your money like none other, it becomes difficult to recognize what has to be a sleight of hand. A potent mix of your own behavioral biases sees to that. Plus, Madoff’s set-up lacked any of the checks and balances you should demand from your advisor. Without an independent third party custodian reporting directly to you (such as Schwab, for our clients), it’s too easy for a con artist to fabricate a reality that doesn’t exist.

Unfortunately, while magic is entertaining, losing your wealth to a deception is no fun at all.

Bottom line, if any money manager claims to be delivering constant, consistent stock market returns for years at a time while the markets swing up and down, you can almost certainly assume something’s amiss.

Back to Evidence-Based Reality

Unfortunately, these kinds of tricksters put us real advisors at a disadvantage. Unlike Madoff’s portfolios, ours won’t deliver magically positive percentages every month of every year – or even every year. Instead, we employ evidence-based investing to guide us through markets whose expected long-term returns are typically delivered in unpredictable fits and starts.

That means, as a realistic investor, you must be willing to tolerate the risks involved when you Take the Long View®. This does not mean you must accept excessive risk. There are a number of ways to manage the downturns while maximizing expected returns:

• Avoid concentrated risks by employing broad, global diversification instead of trying to pick individual stocks or time the market’s movements.
• Establish enough liquid (spendable) reserves to tide you through market downturns without being tempted or forced to unwind your long-term investments.
• Judiciously seek higher returns when warranted by tilting your equities toward expected sources of added risk and return – such as small-cap value stocks.

Likely vs. Certain = Reality vs. Fantasy

Are we SURE our approach is going to work? Do we KNOW, for example, that small-cap value stocks WILL provide premium returns over time?

We cannot be certain. After all, the value premium has disappointed during the past decade. Ten years might tempt even a resolute investor to waiver.

However, while we cannot be certain, we can shoot for most likely, based on the strongest, longest-term evidence we can find. In that context, the evidence clearly informs us that a decade of underperformance in any given asset class is not only possible but is periodically expected.

As this chart from Dimensional Fund Advisors demonstrates, since 1926, the value premium has outperformed growth 84% of the time across nearly 1,000 overlapping 10-year timespans. This means, 16% of the time (during around 160 decade-long periods), it has not.

If you’d like to ponder this phenomenon at greater length, here’s the Dimensional paper from which we extracted this chart.

We also encourage you to read “Factor Fimbulwinter” by Corey Hoffstein of Newfound Research. Admitting that the recently “disappearing” value factor (as measured by price-to-book) could well signify either the death of the premium, or simply a decade of expected variance, Hoffstein calculated how long it should take to be able to determine which conclusion was correct. The answer: 67 years.

He concludes (emphasis ours):

“The problem at hand is two-fold: (1) the statistical evidence supporting most factors is considerable and (2) the decade-to-decade variance in factor performance is substantial. Taken together, you run into a situation where a mere decade of underperformance likely cannot undue the previously established significance. … In investing, factor return variance is large enough that the proof is not in the eating of the short-term return pudding.”

Larry Swedroe also recently analyzed the durability of various investment factors and reached similar conclusions. In his article, he observed:

“[O]ne of the greatest problems preventing investors from achieving their financial goals is that, when it comes to judging the performance of an investment strategy, they believe that three years is a long time, five years is a very long time and 10 years is an eternity.”

Planning for Uncertainty

Of course most of us don’t have 67 years to wait before we decide whether a market factor is a sure winner or loser. Favoring reality over fantasy, here’s what we suggest:

1. Incorporate the most robust academic evidence suggesting which risk/return factors to favor.
2. Tilt your globally diversified portfolio toward those factors (as needed to reflect your unique goals).
3. Stick to the plan for a long, long time; avoid acting on hopes or fears, favoring only judicious adjustments when warranted.

What’s the alternative? While Madoff is history, we can point to any number of unsavory schemes that continue to be perpetrated by a seemingly never-ending supply of similar scoundrels. So whatever you do and whoever’s advice you choose to take, here’s one tip worth taking to heart: Always be wary of a “sure bet.”