The only thing worse than investing in the stock market last year was investing with Bernard Madoff, whose alleged Ponzi scheme is said to have cost investors as much as $50 billion.

Many of the people who lost money because of Madoff should have known better. His victims included big banks and even Henry Kaufman, a well-known Wall Street economist. Many advisory firms that were in the business of vetting hedge funds before recommending them to clients failed to warn their customers away from Madoff. Even Stephen Greenspan, an emeritus psychology professor who just published a book titled -- no kidding -- "Annals of Gullibility: Why We Get Duped and How to Avoid It," fell for the scam.

Why did so many sophisticated investors turn out to be so gullible? What can you do to avoid their fate?

Investors were fooled because Madoff had a sterling reputation, and he and his marketers had personal relationships with many of the victims. You tend to trust experts you know well and who've given you good advice in the past.

Shrewd investors would have smelled a rat had Madoff promised enormous returns. So he offered relatively modest returns, about 1 percent monthly. Surprisingly, psychological studies have found that investors almost always choose small, consistent returns over big -- but uncertain -- payoffs.

I considered Madoff perhaps the savviest market maker on Wall Street. He set up electronic systems that matched buyers and sellers, often providing them better prices and faster executions on stock trades than the New York Stock Exchange did. At one point, he was chairman of Nasdaq.

Madoff was widely admired and seemed to have boatloads of money. He had no apparent reason to steal a dime, solidifying investors' trust in him. And yet steal he did. His motive remains a mystery.

KEEP IT SIMPLE

How can you protect yourself against his ilk? Investors who keep things simple could never be scammed the way Madoff's prey were.

From my experience, investors often court trouble when they get fancy. You can make money dabbling in options, shorting stocks, buying complex securities and trading frequently. But most of the time, you don't.

Incredibly complex securities based on subprime mortgages triggered much of the current financial crisis. But mortgage derivatives are hardly new; 15 years ago, they were responsible for the implosion of Piper Jaffray Institutional Government Income fund. Manager Worth Bruntjen beat funds that invested in ordinary mortgages, such as Ginnie Maes, for several years, but his fund plunged 30 percent in 1994. Piper was fined more than $1 million, and the firm paid $67.5 million to settle investor lawsuits. Continued...