It is not about intelligence for those who fall for pyramid schemes

Here, they rationalise their decision with the retort “everyone else is doing it”. That could explain how investors jumped on to the pyramid band wagon, some after being egged on by the religious folk and men of the cloth.

But still, why would an individual commit his entire savings in a single entity? According to prospect/loss-aversion theory, people prefer a sure investment return to an uncertain one.

That is pretty reasonable. But a strange part is that the prospect theory suggests people express a different degree of emotion towards gains than towards losses.

“Individuals are more stressed by prospective losses than they are happy from equal gains,” says Mr Ocholla. The theory also explains why investors hold onto losing stocks; people often take more risks to avoid losses than to realise gains.

Just like in Kenya, Michael S. Rosenwald wrote in Washington Post early this week that many investors — charities, individual investors, even well-known fund managers — have lost everything, right down to their last penny.

How could so many smart people do something that, in hindsight, seems so dim-witted? The answer is simple. No matter how accomplished, experienced or savvy, people succumb to age-old human behaviours — and failings — when making investment decisions.

Take Mr Eliud Thuku, for instance. He resigned from a teaching job in 2006 at the height of the pyramid craze and opted to put his entire Sh330,000 savings in three schemes.

“I was earning a good interest totalling Sh18,000 per month and decided to feed on that as I searched for what to do,” says Mr Thuku who had only received three months interest when disaster struck.

In over-allocating money to one position, investors are typically prone to several short cuts that get them in trouble. One primary mistake is uniquely intertwined with Madoff’s alleged scheme — the allure of small but consistent gains.

Similarly, a chart of Madoff’s purported returns shows a line going steadily up, month after month, one or two per cent. Those kinds of gains are intoxicating.

Both scenarios also exposed a persistent problem among all investors: failure to do timely re-balancing of their portfolios.

An Alliance Bernstein survey of 1,000 investors showed that nearly 40 per cent of investors without an adviser did not have an approach for allocating and re-balancing investments.

Some 55 per cent of those people reported that they never got around to doing it. Mr Ocholla puts it this way: “Too much of any one type of investment is risky. It is important to note that diversification is not achieved by having lots of different types of equities or different types of bonds or any other asset class.

Trusting nature

Instead, diversification is achieved by a prudent mixture of non-correlating asset types, which means you generally need at least all three - bonds, equities and properties along with other funds.”