A recent exposé by 60 Minutes on Nancy Pelosi’s insider trading activity and the resulting media storm have left much of America agape. Can it really be that the same congressional leaders that have established laws to firmly punish insider traders such as Martha Stewart, the insider king Raj Rajaratnam, and just this past week Diamond Back Capital and Level Global, are themselves exempt from the rules? Sadly, under the status quo, they are.

According to reports, former House Speaker Nancy Pelosi bought stock in an initial public offering that earned hefty returns while she had access to insider information about pending legislation likely to impact those values. Additionally, just days after a private committee briefing during the 2008 financial crisis, Spencer Bachus purchased stock options that proved quite profitable through the downturn. The irony that Mr. Bachus is currently the chairman of the House Financial Services Committee is palpable.

And if you have doubt that this problem is widespread, all you have to do it look at the results of a recent study that reveals the average portfolio returns of congressmen and senators. As reported in the Wall Street Journal, these leaders consistently outperformed stock indices like the Dow and the S&P 500 and the returns of professional money managers.

In academic studies from the Journal of Financial and Qualitative Analysis, statistically significant results demonstrate that both Republican and Democratic politicians are outperforming the market, with the Democrats enjoying a whopping 9 percent annual outperformance. Senators were the biggest winners, displaying Houdini-like magic and beating the S&P by 12 percent annually. These results are not due to luck or financial acumen, but are rather the result of trades based on non-public information that these politicians are privy to in closed-door sessions. For the rest of us hard-working and investing Americans, this type of advantage is called insider trading.

Obviously, behavior that is criminal for everyday Americans should not be okay for lawmakers who have the power to gin up laws that affect companies while simultaneously keeping an eye on their own spreadsheets and brokerage accounts. Sadly, however, this is in fact the case.

Congressional immorality seems to extend beyond this insider debacle. Recent reports have revealed that Countrywide provided special VIP loans with publically unavailable discounted interest rates to representatives. There was even a rumor this past month concerning student loans given to congressional family members that are later forgiven. Further research by Snoops.com and others revealed that these forgiven student loans are just for a limited group of staff members who work for our elected officials. Well, there you go; finally some moral fiber. It leaves those of us struggling to get our retirement portfolios on track to wonder if there is a way to pick up one of these staff member positions, or better yet become a lawmaker to get to the real juice.

Some may be old enough to recall Newt Gingrich and Dick Armey’s Contract With America. Amongst such common sense things as a balanced budget amendment, congressional term limits, and “loser pays” tort reform was a cornerstone section that stated: “All laws that apply to the rest of the country also apply equally to Congress.” Here is something that should unite Tea Party members right through Occupy Wall Street protestors: legislation that requires lawmakers to play by the same rules as the rest of us.

Now, due to this dust-up, Congress is pursuing legislation to address the insider trading problem. The STOCK Act seeks to require lawmakers to publicly report all trades within 90 days. Those in the know say this law does not go far enough and that immediate and transparent reporting is necessary on all trading. Unfortunately, the real answer should be moral rectitude in the form of public servants constrained by an internal sense of conviction that they must serve the country and not themselves. This conviction should second nature, but it is no longer clearly evident in congressional behavior. The fact that we have to codify this ethic in writing shows just how bad Washington has sadly become.

On the one hand, lawmakers have been passionate about confronting corruption on Wall Street. From Sarbanes-Oxley to Dodd-Frank, politicians have sought to weed out the next Enron, stop the next Madoff, and avoid the next Lehman collapse and MF Global bankruptcy. All the while, as they slap the hands of others, they too are burying their hands up to their wrists as they riffle through the cookie jar.

While index investing cannot hold a candle to the results these insiders enjoy, this mess underscores why a passive approach to your portfolio is the smartest way forward in this unfair world. While it is hard enough to build a smart and globally diversified portfolio, it is virtually impossible to compete with those who enjoy their insider advantage. By keeping your investment costs down and your bets widely spread across many markets, you will enjoy the rewards of long-term and tax-efficient market growth. If you want to jump into the ring, one hand tied behind your back, and fight the pros with insider insight, then good luck.

Any while many investors had previously never heard of MF Global, the firm’s failure led to an approximately 10 percent single-day hit to financial stocks. A better understanding of the MF Global debacle may help you exorcise the goblins that may be lurking in your investments.

Indecent exposure

Apart from the alleged $700 million in missing money and illegal activity, MF Global’s core investment problem was its gun-slinging investment approach towards the sovereign debt of Portugal, Ireland, Italy, Greece, and Spain (better known as PIIGS).

Upon filing for Chapter 11 bankruptcy Monday, margin calls of some $6.3 billion in Eurozone debt was revealed. That’s five times the size of MF Global’s equity. MF Global placed a very large bet on PIIGS and in the end, it got stuck in the mud. Ironically, MF Global’s homepage mission statement reads: “Working relentlessly to bring our clients superior market access, hardworking insights and powerful trading and hedging solutions.” If accusations of wrongdoing prove true, they apparently left out: illegal use of funds, shortcuts, and daredevil investing. Powerful indeed!

Just when you begin to feel a bit of relief that your retirement dollars aren’t with that firm, a bit of research reveals that U.S. bank exposure to PIIGS and Eurozone debt is substantial. According to a recent report by the Congressional Research Service, nearly 5 percent of total U.S. banking assets are in PIIGS. That may mean your institution is silently at risk as well. Add to the sobering $641 billion in PIIGS exposure by U.S. banks $1.2 trillion in exposure to German and French banks and you are left with significant risks to U.S. banking infrastructure in the event that the Eurozone goes caput.

This brings us back to our investment primer—be a hawk at diversifying assets and managing risk. Warren Buffett’s famous maxim for investing is simple: “Rule One: Never Lose Money. Rule Two: Never Forget Rule One.” In the case of MF Global, rule number one was long forgotten in favor of leaning dangerously out to grab the brass ring. How does your investment portfolio look when it comes to risk management? Do you have global exposure to six or seven asset classes, or are your investments all stuffed into one asset class in a reach for high returns?

Will the big bad wolf blow your house down?

Worse yet, initial statements seem to indicate that MF Global had more than poor asset allocation to worry about. According to a board member at the Greenwich, Connecticut, firm Interactive Brokers, there appears to be at least $700 million missing from client accounts. Interactive Brokers was pursing a possible acquisition of MF Global when the alleged wrongdoing emerged.

Broker-dealers are charged with keeping client funds separate from company dollars, but according to testimony, MF Global used client money unbeknownst to clients for its own internal investing. How can an investor know if his broker is behaving similarly? The obvious answer is one can’t. Surely, however, placing funds under the care of one of the leading discount brokers that is less inclined to get involved in more esoteric investment banking activities is a start.

How safe is my money?

Moody’s downgraded MF Global last week. This downgrade was met by MF Global’s CEO publically minimizing the rating adjustment. In fact, while MF Global was swirling the toilet, its marketing arm was simultaneously sending out letters to clients reassuring them of the firm’s strength. Once calamity struck, clients who called MF Global on Monday were met with nothing more than a voice recording.

When a similar catastrophe strikes your broker, how do you know your money is protected? Investors may be aware of the Securities Investors Protection Corporation, a government-created entity which provides account insurance and oversees liquidation proceedings. Not all accounts have SIPC protection, so the matter of first importance is to confirm that your account is covered.

If your dollars are in fact covered by SIPC, you must understand the SIPC is not a guarantee that you will receive all lost funds. Unlike the secure promise of FDIC bank account insurance, SIPC coverage must be applied for within a designated deadline and may not cover all forms of fraud. It is the responsibility of the investor to provide the appropriate proof of assets and documentation with his application.

Kevin Bell from SIPC was asked about the process. “What customers ask is, ‘When am I getting my money?’” said Mr. Bell. “You tell them to sit tight, and start gathering their information so they can file claims.”

Some investors thought they had their money securely tucked away in a credible investment house. This week they awoke to their own nightmare to discover that their money was locked away in a house of horrors. Take some time to do a bit of research and vet your broker. Find out what their PIIGS exposure actually is. See if they in fact have high ratings from the ratings agencies. And keep a copy of your records close at hand.

Lining his own pockets with over $63.8 million in illegal windfall from his insider scam, this once humble Sri Lankan son of a sewing machine company manager grew in physical, egotistical and financial stature. Through his swollen cheeks he crowed to friends about his $7 billion hedge fund empire, stating that Raj, which stands for “King” in Sri Lankan, makes him the “King of Kings”. How about the Insider King instead?

Indeed, Raj Rajaratnam, did gorge himself like a king, but on more than just Kobe beef. Using techniques once reserved form organized crime, drug trafficking and terror plots, the Justice Department was able to convict the Insider King of 19 accounts of security related fraud. And his conviction involved a complex web of over 23 known complicit parties ranging from corporate executives to hedge fund managers revealing just how deep this insider culture truly runs among the Wall Street elite.

With the spotlight temporarily on this aspect of the malevolent hedge fund underworld, it behooves us to pause and underscore a few key lessons for the everyday investors.

Lesson #1 – The Little Guy Can’t Win

Every now and again you run into that day trader or active investor who has discovered the “golden cross” of technical analysis or has gained some yet-to-be perceived insight into the global economy which he is poised to exploit.

Forget the fact that thousands of financial researchers churned out of the top ivy league schools are employed by leading hedge funds, equipped with staggering research budgets, sophisticated analysis technologies and shocking financial rewards for success. Forget that these researchers are probably a bit smarter than you. Forget that they crunch data like auto bots, day after day looking for any edge. Forget that even if the playing field were level, you would have to be a bit deluded to want to compete against such a formidable opponent. Then add to these facts the simple Insider King illustrated reality that these organizations sometimes get trading information first – illegally, and the answer becomes simple. The little guy cannot win.

For the individual investor, active stock trading is nothing short of Popeye fighting Bluto with no spinach in site. Such a contest is so one-sided that it goes from being entertaining, past pathetic to downright disgusting. As the Las Vegas adage goes, “look around the poker table and if can’t spot the sucker, it’s you.”

Lesson #2 – Fees Really Do Matter

What does 2 and 20 mean to you? Probably not much unless you have read the prospectus for a hedge fund. The going rate for playing in the hedge fund game is a 2% annual management fee on assets under management and then a 20% profit share on all earning. This is the fee burden the hedge fund manager must overcome to return value to the investor group.

With such a heavy fee burden, how then does long-short equity hedge fund manager return value? He does so through building teams that perform deep research, astute analysis, and rapid response systems which exploit the smallest window of opportunity. And sometimes he do so, as the Insider King has shown us, through insider information. Surprisingly, even with all these resources and advantages, many hedge funds over time fail to even beat the market. 2 and 20 is a lot to overcome.

Lesson #3 – Some Things Never Change

Yes, the Galleon verdict is an encouraging example of justice, but just how deep is the insider problem? According to the Cayman Islands Monetary Authority, there are over 5000 hedge funds representing over $2.3 trillion in investments. And although many of these funds conduct ethical enterprises, the dollars at play provide a substantial motive for misbehavior. Galleon is just the tip of the iceberg.

When malfeasance turns up, however, investors are frustrated by the fact that many cases are lost in court or end with nothing more than a wrist-slap. The not-guilty verdicts for Bear Stearns hedge-fund managers accused of misleading clients, Angelo Mozilo’s multi-million settlement to erase fraud charges with the Securities and Exchange Commission, and the lack of indictments against Wall Street executives for misdeeds in the financial crisis are all examples of injustice winning the day. One commentator likened these efforts to a fruitless and frenetic game of whack-a-mole. You may strike a mole here and there, but a lot more disappear into their hole to never face any consequence for their action.

Although we applaud the conviction of the Insider King, remember that when it comes to Wall Street, some things never change.

The individual investor, however, need not despair. Through simple indexing and global diversification, you can tap into the value of corporate productivity and global economic growth and thereby side step the rigged world of active trading. Add to this the discipline of vigilantly driving down all unnecessary fees within your portfolio, and in the end, you may in fact have the last laugh, even on the Insider King.

There is no industry more ridden with conflicts of interest and misaligned incentives than investment management. David Swensen, the Chief Investment Officer of Yale University (one of our MarketRiders experts) writes:  “Relationships with external investment managers provide a fertile breeding ground for conflicts of interests….  (we) seek high risk-adjusted returns, while outside investment advisers pursue substantial, stable flows of fee income.”

To properly evaluate any financial advice you are given, you must understand the incentives of the adviser.  If your broker or insurance agent is your best friend, remember that he feeds his family by selling you “products” that may not be best for you.  The financial adviser you pay by the hour may talk a little too much and be pedantic in delivering his advice to keep the meter running.  Those who are paid a percentage of your assets want more of your money.  We explain these incentives in more detail on our website How Wall Street Keeps You at the Table.

Regulations in the financial services industry put another and more subtle dimension on incentives for advisers.  Did you know that a Broker / Dealer works under different legal standards than a Registered Investment Adviser?  Did you know that a Certified Financial Planner must pass much more rigorous examinations than brokers or advisers?  We’ve brought you articles this week so that you can be more informed about these issues and upcoming regulatory changes that could impact you.

Speaking of incentives, our August 14th newsletter comparing the mutual fund industry to the tobacco industry ended up in the New York Times which prompted the VP of Research at Morningstar to make dismissive comments about our arguments.  Applying the Freakonomics incentives concept, we publicly bet him that a portfolio of 10 ETFs recommended by MarketRiders would beat 10 Morningstar 5-Star rated mutual funds.  He refused to accept our wager.  We weren’t at all surprised.  After all, he’ll make much more money perpetuating the myth that his system works, than losing his own money by actually using it.

The impact of these laws, however, remains unclear. Some argue that they don’t go far enough, while others see them impinging on corporate growth and hampering our weak recovery. Still others believe that these laws are so convoluted that it will take years for practical benefit to trickle down to individual investors.

At MarketRiders, we believe there is a bigger question – not simply a question of whether Big Brother will protect me, but more specifically, will I protect myself? Am I willing to perform the keen analysis and critical thinking required to protect my retirement dollars from malevolent forces that seek to get rich at my expense? Let’s face it – you were smart enough to make the money. You are probably smart enough to protect it as well. By removing unnecessary intermediaries, reducing fees, diversifying, and investing in assets you understand, you can enact your own highly effective financial reform without the aid of Congress.

The 60′s revolution brought new meaning to the phrase. The modern candyman became the conniving drug pusher who offers unaware teens a “good time” through free or low cost drugs. His strategic marketing plan was simple and has survived to this day – get kids hooked now and garner huge profits later.

Sadly, some who offer financial advise have taken a page out of the candyman’s playbook. The promise of sagacious advice that will enhance one’s wealth, access to elite and high-performing investment products, and of course, eye-popping performance statistics ridden with fine print qualifiers, lure the investor in. Quietly, the needle is slipped into the investor’s brokerage account and invisible, hard to detect commissions, management, 12b-1, trading, and front-end and back-end fees drain away hard-earned savings. Wall Street reaps huge rewards while investors slowly and quietly lose.

Discharging the investment adviser candyman is often a scary proposition. But like many MarketRiders members have found, liberation from high priced investment help is good for the spirit as well as the retirement account.

Sadly, it was no surprise to learn the Goldman Sachs threw their clients “under the bus” by deceitfully selling them mortgage securities while at the same time making a killing on shorting the housing market.  Their slogan, “Helping clients build and preserve their financial wealth” needs a minor adjustment. “Helping clients build and preserve OUR financial wealth.” This is a paragon of the Wall Street ethic – make money (hmmm – a lot of money) even if you must trample your client under foot. When you manage your own diversified portfolio of ETFs through a MarketRiders account, you truly get Wall Street out of your pocketbook by removing the intermediaries.

The Wall Street gurus seem to have a closet full of tricks to help investors outperform the market. Unfortunately, most of this advice is unproven and ineffective. In this MoneyWatch article, James Picerno points out one of the ONLY scientifically proven secrets to boost portfolio returns year-upon-year – disciplined rebalancing. Mr. Picerno underscores that rebalancing can deliver a 0.5 to 1.0 percentage point annual bonus compared to what you’d earn on the same portfolio that’s left alone. Our research shows that by using MarketRiders’ advanced rebalancing algorithms rather than a simple calendar based approach, investors add up to 2% additional growth in some portfolios and market conditions. We have more on this topic here: “How Often Do I Need to Rebalance?”.

When it comes to retirement investing, remember that you don’t have as many friends in the financial services industry as you think. By taking the time to learn the virtues of low cost indexing, global diversification and disciplined rebalancing, you will truly build and preserve YOUR wealth.

Think of the conversations that occur behind closed doors at the White House, corporate boardrooms or U.S. Central Command. We all understand that there are elements of those conversations that are deemed, for whatever reason, unsuitable for public consumption. They are tucked into the classified file, sworn to secrecy and solemn oaths. But every now and again, some of the untold story leaks out – finds its way to the common person. Sometimes the information is so unbelievable, that it is marginalized as ridiculous. Other times it is corroborated with such credibility that all we are left with slack jaws and nodding heads.

Below are three brief but shocking behind-closed-doors accounts about Wall Street and investing that left me stunned.

CEO of a Top Publically Traded Tech Company: Having participated in the Silicon Valley for years and sat on the board of Baidu, I come into contact with a broad network of technology leaders and professionals. Recently, I became part of a stunning conversation with one of the top executives in The Valley.  This individual, while surprising humble, is also profoundly wealthy. For years he used the “top” wealth managers who have access to elite money managers who in turn “outperform” the market to justify their fees. After years of high cost and poor performance and tens of millions lost, this executive was seriously underwhelmed. He pulled his money out, embraced a simple indexing strategy and global diversifications. It takes him only a few hours a year to manage the money himself. He save hundreds of thousands if annual fees and achieves a much better result. Why don’t we ever see that ad during Wimbledon?

Former Banking Firm Top 500 Producer: Imagine being an investment advisor who has built a dream business – over $1B in assets under management (AUM) and a coveted Chairman’s Club member. Making just over 1% a year on AUM, this wealth manager was grossing over $10MM annually in fees. Unfortunately, he had a huge problem – he still had a conscious. The more he study active money management, the more he learned that it not only failed to add value to his customers, but was in fact deleterious.  When he approached management about this problem and sought an indexing approach, he was run out of town. After a legal battle and negotiations, the firm and the manager struck a settlement. He left his customers in the hands of the banking firm and he had to move on. I guess someone is now making money “the old fashion way – earning it.”

$750 An Hour Tax Attorney to the Uber-Wealthy: I was once invited into a private conversation with the uber-wealthy about tax management. The strategy was architected by top legal minds in the country. Profoundly expensive to set-up and maintain, this apparently legal and sophisticated offshore strategy would result in profound tax reduction. Imagine most of your wealth free to compound without tax consequence. These uber-wealthy could invest in the most sophisticated and elite products. When I asked the attorney what the majority of his clients were investing in, he just snickered. Over 60% of their dollars were dedicated to simple and diversified indexing strategies. There was no Wall Street, no active managers, or Jim Cramers – just hundreds of millions, even billions, going into a simple, proven approach used by those in the know.

I hope you are doing the same.

Second, according to the NY Times, if you want to be considered “in the know”, just start talking about ETFs at your next party.  The wave is sweeping the investment landscape and investing in them might soon be considered “cool.”  ”Average investors haven’t really latched onto perhaps the biggest investing innovation of the past two decades.  Despite being low-cost, tax-efficient and easy to buy or sell at a moment’s notice, exchange-traded funds remain largely the domain of institutional investors and stock-market aficionados.  ‘Main Street still barely knows what they are,’ acknowledges ETF expert Matt Hougan of IndexUniverse, an independent Web site on exchange-traded and other index funds. That may soon change.”

Third, one of our Experts at MarketRiders is John Bogle, the founder of Vanguard.  When he writes in the Wall Street Journal, we listen.  There’s a group of investors so enamored with him, that they host a popular and growing website dedicated to following his investment theories: www.bogleheads.org. Jane Bryant Quinn lists this site as her favorite. Bogle’s editorial is well worth reading.  He writes:

“(At the end of 2009) I concluded that ‘the faith of investors has been betrayed.’ How so? Because the returns generated by our corporate stewards have often been illusory, created by so-called financial engineering and produced only by the assumption of massive risks. What’s more, too many of our professional money managers have failed to act as vigilant stewards of the money that we investors entrusted to them.”

We can’t emphasize it enough — maintain an asset allocation that’s good for you so that you have diversification, and own ETFs in each asset class.

“If it sounds too good to be true, it probably is.”  Instead, I encourage serious retirement investors to stick with the strategy used by the world’s best investors.  Focus on asset allocation, globally diversify, keep fees down with indexing, and rebalance to stay the course.  For many that have gotten caught up in a Ponzi scheme or know of friends that have, now might be the perfect time to take matters into your own hands and start to manage your own investments.  Many of the tools available today will guide you on how to invest your money with the goal of generating the most returns for retirement, accounting for risk and time frame, at a low cost.  Try reading several Investing 101 articles that are out there as they are loaded with lots of great tips on finding the best investment vehicle for you.