“Hacker attacks on brokerage accounts make sense from a criminal’s point of view. Brokerage accounts tend to have higher balances, making them worthwhile targets. And while a six-figure transfer out of a checking account would surely trigger fraud pattern detection software, large transfers from brokerage accounts are fairly standard.”

The problem for you is that there is a different level of protection for brokerage accounts by law than for your bank account or credit card:

“Both credit card transactions and electronic account transfers, such as online banking payments, are governed by Federal Reserve regulations that strictly limit consumers’ losses from theft. Consumers who report credit card fraud are only liable for $50; liability for fraudulent checking account transfers is capped at $500 if the consumer reports the theft within 60 days. Refunds for checking account thefts must generally be issued within 10 days.

The regulations are designed to boost confidence in the systems. But the Federal Reserve doesn’t regulate investment firms, and the Securities and Exchange Commission doesn’t mandate any similar protections for brokerage accounts.”

The big question for you is what you can do about it. Here are a few suggestions:

1) Figure out both the policy of your investment firm on refunds and whether they have any insurance. Charles Schwab and E-trade have good guarantees according to the article. I have accounts with Fidelity and Vanguard and went to check out their web sites for information on it. Fidelity doesn’t say anything about insuring the accounts, but they have a “Customer Protection Guarantee” stating that:

“We will reimburse your Fidelity account for any losses due to unauthorized activity.”

The only problem is that the fine print gives them quite a bit more leeway. There are some vague statements about it being “through no fault of your own” and a statement that “it also does not cover unauthorized activities resulting from a breach of security in an employer or plan sponsor’s systems.”

So it’s a blanket guarantee blaring in bold at the top, but some inconsistent statements in the fine print that you could get caught up in. What if your password gets stolen from your computer by spyware? Are you at fault? And how are you supposed to control your employer’s computer security?

On Vanguard’s site I couldn’t find anything – no mention of insurance coverage for this, and while they had some advice about security precautions, there wasn’t any indication at all that they’d reimburse you. I’ve got an e-mail in to them to see what they say.

2) Update your computer’s anti-spyware software and anti-virus software. Spyware, for the non-geeks, is a program installed without your permission that can monitor what you’re doing online – things like typing in a brokerage password. It is often installed without you ever seeing anything by web sites you visit. A virus can also take control of your computer to send out information you’ve typed in to a hacker. For spyware, a good free program is AdAware, which you can download for free here. For viruses, Norton is probably the best (or at least a very good, trusted program). You can get it here – they sell an Anti-Virus program as well as what is called a “Firewall,” which is just a way to stop people from accessing your computer over the Internet without permission. It’s not free, but it’s pretty cheap.

3) Don’t log into your brokerage from a computer you don’t know is secure. This means no computers that other people can use (libraries, Internet cafes, etc.). It might mean the computers at your office, too, depending on where you work and how much you trust the security.

4) Write your passwords down on paper – not in a document on your computer. Those are much easier to steal and could be grabbed by anyone who gets access to it.

5) Don’t EVER log into any account from a web page you accessed by e-mail. ALWAYS go to your browser and then type in the address yourself. I don’t care if the e-mail looks legitimate – this is a very common scam, and you should never follow a link from an e-mail to a site where you’re going to have to type in a password. What people will do is fake a web site and send you a fake e-mail that looks like it is your monthly statement or that says you have a problem with your account. When you click to view it, you are taken to a web site whose sole purpose is to find out your password when you type it in.

6) If you’ve got a lot of money and aren’t satisfied with your brokerage’s reimbursement policy, call them up and ask them to confirm any withdrawals by phone with you. If you don’t think you’ll be taking any money out in the near future (or at least not regularly), ask them to restrict your ability to do so without confirmation. Not every brokerage may be able to do this, but it’s worth a try.

7) Don’t ever give anyone your password. This should be common sense – but don’t do it.

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“A final behavioral test focuses on overconfidence. We know from our prior work that active traders are more likely to be affluent males, and other research suggests that such individuals may be overconfident generally and also overconfident with respect to portfolio trading in particular.” 

This reminded me of another, more general study on incompetence (defined not in the “you’re an idiot” sense, but in the sense that you aren’t capable of performing a specific task). The basic conclusion of that study? People who are incompetent don’t know that they are – and generally vastly overestimate how well they are doing:

Asked to evaluate their performance on the test of logical reasoning, for example, subjects who scored only in the 12th percentile guessed that they had scored in the 62nd percentile, and deemed their overall skill at logical reasoning to be at the 68th percentile.

Similarly, subjects who scored at the 10th percentile on the grammar test ranked themselves at the 67th percentile in the ability to “identify grammatically correct standard English,” and estimated their test scores to be at the 61st percentile.

That’s somewhat surprising – you’d think that someone who wasn’t competent at something would know it. But instead, the natural human tendency is to assume that you’re doing well, even when you’re failing badly at a particular task. Your incompetence actually tends to magnify this effect – you don’t know enough about what you’re doing to know that you’re doing it badly. And this same rule applies to investing. Active traders, on average, get lower returns because there are a whole lot of them who really shouldn’t be doing it – but have convinced themselves that unlike all the other amateurs, they know what they’re doing.  If you’re a person who actively trades your investments, you may well be good at it, but odds are that you aren’t. In fact, most people reading this who think they are good at investing are probably, in actuality, pretty bad at it. Investing is one of those things where it’s easy to delude yourself into thinking you’re a genius. Sometimes it’s because of luck – you bought some property in California in 1996. Sometimes it’s because the yardsticks aren’t that easy to read. You gained 15 percent on your portfolio last year, and beat the S&P! But over a 10 year period, your strategy ends up underperforming it. Sometimes you don’t keep all that close an eye on how you’re doing overall, and just see the investments going up – even though that’s what they tend to do over time for everyone.

The point is that if you’re actively trading your portfolio, you need to take another look at that strategy. It’s very hard to “beat the market” over time. Even professionals don’t do it consistently, with a few exceptions like Warren Buffet. And if you think you’re beating it, odds are that you just don’t know enough to know that you don’t know what you’re doing.

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But at this point, I think we’re as likely to see a return to the stagflation of the ’70s as we are to see a revival of leisure suits and hot pants.

He did give you some advice on how to set up your portfolio if you’re convinced we’re about to enter a period of economic decline. The assets that did well in that period include bonds, commodities like gold, and real estate – the latter two because they are physical assets that aren’t as subject to inflation as “paper assets.”

The problem with this strategy: you could guess wrong. In the long run, it’s better to just invest in stocks, which will grow over time even if the economy hits a rough patch. The people who try to game the market usually end up underperforming it on average. If you’d set up your portfolio like this in 1997, when people were talking about an Asian financial crisis that was going to derail the world economy, you would have missed out on the stellar returns of the stock market for the next three years – even if you’d just stayed in past the decline in 2000-01, you’d still be much better off.

The point is that these predictions happen all the time, and they’re usually wrong. In the 1980′s Japan, Inc. was going to crush us – they were buying all the U.S. real estate and our businesses couldn’t compete. In the late 80′s and early 90′s it was the trade deficit – a recurring bogeyman that has been predicted to kill off the U.S. economy ever since. The recession in the early 90′s, combined with the budget deficit, were the next big thing that would lead to a permanent U.S. collapse. These warnings have been issued over and over again – and they’ve all got a Y2K quality about them.

In fact, Y2K stands out to me as the quintissential “disaster theory” because it embodies this tendency. People are afraid of big, scary scenarios, and they tend to overestimate these risks. When’s the last time you ever heard any journalist or media member, anywhere, mention Y2K? On December 31, 1999, we were all doomed and needed to stay indoors to keep planes from crashing on us. On January 2, 2000, it was never spoken of again – despite being a colossal blunder that resulted in $121 billion being wasted trying to avert it! In fact, when I was searching for that cost estimate, I couldn’t find a SINGLE ARTICLE, blog post, or anything criticizing this spending. Every mention of the costs was from 1999. Russia and many other countries didn’t spend a dime – and didn’t have a single problem, either. So we waste a hundred billion dollars, spent years with people worrying themselves silly, buying survival gear and cabins in the mountains, and the end result is that we collectively decide never to speak of it again – even though we’re constantly being bombarded with new, speculative disaster theories in every field that have about as much validity. Think about this before you decide to bet your entire portfolio on the assumption that the world is going to blow up. It’s been thought before, it’s been wrong before, and it’s probably going to be wrong again.

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Sounds great? Getting a spam means the stock is going to go up, so you should buy in! Wrong – people who do that lose money:

Selling by the spammer then results in negative returns following touting. Investors who respond to touting are losing, on average, 5.25% in the two day period following touting. For the quintile of stocks in our sample that are touted most heavily, this 2-day loss approaches 8%.

Frankly, I’m a little disappointed in humanity to know that people would actually buy a stock based on a spam e-mail advertisement. You shouldn’t be one of them – there isn’t a good reason to do it, because you’re always going to be on the tail end of the buying, risking a loss as selling starts. Even if you want to trade penny stocks, you don’t want to be doing it in the wake of somebody else who’s manipulating the price. They gain money by taking it from the suckers who read the e-mails – namely, you.

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No, many of the modern scams are masquerading as investment opportunities that look legitimate to the uninformed. In fact, far from being something new, a lot of them are just variations of an old and clever scam: the Ponzi scheme. This scam gets its name from a guy named Charles Ponzi who stole about $15 million from various people over short periods in Boston in the 1920′s. How did he convince people to give him $15 million dollars? He promised them that he’d double their money in 90 days – and he did. For the first people that invested, that is. What he was doing was taking money from a small group of people, promising to “invest” it, and then getting more people to invest for the next 90 days. He then used their money to pay off the first people, who doubled their money – and then wanted to “invest” a bunch more, along with all their friends. The Ponzi scheme gains credibility because for awhile, it actually does give people huge returns. But once a certain amount of money gets into the system, the person running the scheme disappears – taking all the money “invested” at that time with them.

So of course no one would fall for this today? Sadly, these schemes are thriving. And the two largest variations are called High Yield Investment Programs (HYIP’s) and Autosurfing. A HYIP is generally based on the claim that there is some sort of investment opportunity generally unknown to the public that the program will let you in on for huge returns. Many of them claim that there is a “secret banking system” where the program will place your money in a bank account and be able to trade it, for free, with no risk. Most of them use complicated sounding language, referring to obscure aspects of the banking system – they may claim to deal in letters of credit or various kinds of banking notes. The FBI has issued a warning stating that these schemes are illegal and that there is no secret banking system which people can use to make sudden profits.

Autosurfing is something slightly different, but it is plainly an illegal scam, and the government is cracking down on these companies. The schemes work by pretending that they are a legitimate advertising company. You can read a breakdown of the tricks used by one company here, but in essence they claim that if you put up a certain amount of money, they will put a program into your Internet browser allowing you to view ads while surfing the Internet. They claim to give you a cut of the advertising revenue, but you have to “invest” to be allowed to join, and you get a “return” only so long as you surf the Internet for a certain amount of time each day. This has at least a veneer of legitimacy – in the Dot Com boom days, there were a few companies that tried to use this as a business model. They went bankrupt because it doesn’t work – paying people to pretend to look at ads isn’t very lucrative for advertisers. But the failed business has become a successful scam because it sounds like something that COULD be true.

So how do you protect yourself from these kinds of scams? First of all, in looking around, I noticed that most people running the schemes aren’t even trying to hide what they are. Most even call themselves a HYIP or an autosurfing program – which makes it more than a little disturbing that people still put money into them. For the ones that try to hide it, I found a good list of tips on avoiding these things here. You shouldn’t really need them – if someone over the Internet offers to give you a huge return for only a small investment, they are scamming you. You shouldn’t be sitting around trying to figure out whether it could be real or not. Once you’ve gotten to that point, you’re a sucker who’s taken the bait. My single rule of thumb for whether an “investment” is a scam or not is this:

Can you call up a broker at Merrill Lynch, Fidelity, E-Trade, or some other famous investment broker and invest in it?

If you can’t, it’s definitely a scam. People who have real investments that are able to make real money will do one of two things: if they can, they’ll get it listed on some sort of exchange, in which case you can trade it using a reputable investment house. If they can’t, they’ll get money from friends and people they know personally – in which case you wouldn’t be hearing about it third-hand from some web site that wants you to invest $200. That rule won’t guarantee you you’re not going to lose money – many penny stocks are garbage companies that you could trade through Merrill Lynch and find out it was a sucker’s bet anyway. But it is NEVER a good idea to “invest” money on some web site you’ve never heard of before.

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The one I’m referencing is from Newsweek, on the “economic miracle” in Europe in which Europe is now growing faster than in the United States. Why does the author conclude Europe has an economic miracle? Because:

In nothing less than a minor miracle, the euro zone is back. The Continent’s major economies beat GDP expectations in the second quarter of the year, resulting in the strongest growth in six years. The euro zone grew almost 1 percent last quarter, outperforming the United States, Britain and Japan. The upshot is that the euro zone will likely grow about 2.5 percent this year—up from 1.3 percent in 2005. What’s more, Slow Europe is now creating jobs faster than the United States: France and Germany in particular saw strong jumps this spring and summer.

This is probably the least informed paragraph I’ve run across in awhile. Right off the bat, anyone who has a passing familiarity with economics should know that these numbers aren’t miraculous. In fact, they’re pretty bad. 2.5 percent annual economic growth is not that great, and 1 percent is pretty awful. For example, this academic article comparing the U.S. and Europe points out that the U.S. has grown at 3.3 percent on average over the last ten years and Europe has grown at 2.1 percent. 2.5 percent is better than they’ve been doing, but no miracle.

Then there’s the idea that 1 percent economic growth in the last quarter is better than other major countries. I can’t tell whether this is just a typo or a failure to do basic research. The most recent official estimates for the U.S. are a 2.5% annual growth rate in the second quarter, down from 5.6% in the first quarter. One percent growth doesn’t beat either of those. The author is right about Japan, which only expanded .8 percent in the second quarter of 2006. But again, basic economic knowledge would tell you that this isn’t exactly impressive – Japan has been in a funk since the early 1990′s, and it’s only a recent trend for their economy to be growing at all.   

I had to go elsewhere to find actual information on the job numbers that are being reported. This article in the International Herald Tribune pegs overall European job growth at 200,000 a month – and it’s also a much more balanced and sensible take on the upswing in the European economy. Those numbers look better than the U.S., which created 113,000 jobs in July. But then we run into that pesky problem of “research” again. The EU also has a population of about 460 million – whereas the U.S. has a population of about 300 million. Which means if you compare for population, the U.S. growth is the equivalent of about 173,000 jobs in the EU – not all that much of a difference.

Why go after some random reporter? Maybe she had a rough day, or a short deadline, or got assigned to write on something she’s not an expert on by an editor. But real people make financial decisions based on this stuff. How would you feel if you put a bunch of money into investments in Europe based on a fluff article that got the numbers wrong? The important thing to take away from this is that no one you read is infallible, even if they’re claiming to be an expert or if you see the statistics in a popular magazine with a nice glossy cover. You need to educate yourself – and if a blog or a newspaper or a book says something, you can’t just trust it. You have to check out multiple sources and know some background material about the subject – because if you rely on something that’s wrong, it’s going to cost YOU money – not the person who wrote it.

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Basically, you just look for companies that are raising dividends at the rate of twice inflation or more – probably around 6% per year now. There are plenty of big, solid companies that meet this category – Helm identifies Proctor and Gamble (PG), Aflac (AFL), and Wells Fargo (WFC) as meeting this category.

The idea behind the strategy is this: management of a company does not raise the dividend unless they believe the company is doing well. If they’re worried, they generally keep it the same or even lower it. It’s a good point – many investors focus on things like the public filings of whether management is buying or selling a stock as a guide to how confident they are in the company. But dividend growth is actually probably a better “canary in the coal mine” that will tip you off sooner as to whether there are going to be problems, because managers often own options instead of stock or will avoid selling when they know there are problems for fear of insider trading issues.

The other thing I like about this strategy is that it pretty much keeps you to companies that are solid financially, while letting you find ones that are growing as well. Companies that are not on a solid financial footing do not pay high dividends. An AOL or a Google that is depending on future earnings growth rather than a high earnings base today has the growth - but not the underlying strength in its business right now. So looking at dividends is a good way of letting you pick the best of the bigger, traditional companies that aren’t subject to as much risk.

I’m not so sure about investing in this guy’s fund, just because it is only a year old and only has $11 million in assets. You can view the details about it here. If you want to try this strategy but don’t want to buy the fund, they have to disclose major holdings – so on that page you can see that he’s also picked General Electric, Johnson and Johnson, and Baker Hughes. If you want to use the strategy but don’t want to spend as much time poring through stocks and running the numbers, just look at the disclosed holdings and research those stocks specifically to see if you like them.

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Only three ingredients are needed: income, discipline and time. Chances are, you already have two of them, income and time. All you need to do is add the third, discipline. And armed with the following knowledge, that key third ingredient may be a lot easier to find.

Here’s how it works: Say you start with nothing, invest $500 (of your income) a month (a healthy discipline), and let your money ride (over time) in diversified investments. Long term, the stock market returns at least 10% annually. Assuming a 10% return, you’d have $102,000 after 10 years, $380,000 after 20 years, and $1.1 million in 30 years.

Most personal finance blogs seem to hammer away at these ideas, again and again. There’s a reason – there’s really not that much to becoming rich. Anyone can do it, even on a small income. Why don’t more people get rich, then? Well, they don’t understand the basics – or they don’t follow the simple rule of investing money every month over a long period of time. Which is why you’ll hear bloggers tell it to you again and again: Figure out a way to save that $500 a month, put it in an index fund, and you’ll retire happy and wealthy.

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