Similar to pyramid schemes, Ponzi schemes promise extraordinary monetary returns on an investment. Both money schemes are self-sustaining as long as the amount of money coming in from new investors matches the cash outflow, thus the whole appearance of successful gains. However, once the number of new investors wanes, so does the money.
How do you recognize a Ponzi scheme? Understand how it works and how to avoid getting scammed by deceitful portfolio managers out of your hard-earned money.
What Is a Ponzi Scheme?
A Ponzi scheme is considered a scam, a fraudulent investment scheme that promises high return rates with little to no risk to you, the investor. Your money does not get invested, but it generates returns for earlier investors with money solicited from new ones. This is what makes it similar to pyramid schemes.
And similarly, both Ponzi and pyramid schemes eventually collapse when new investors stop coming in and there is no longer enough money to disburse.
The term Ponzi scheme was born after Charles Ponzi, a swindler notorious in the early 1920s, targeted the US Postal Service. At that time, the US Postal Service was deploying international reply coupons (IRC) that mail senders could buy and include in their mail. The receiver could then take the coupon to their local post office and exchange it for airmail postage stamps they need to send a reply. Ponzi took to buying IRCs from one country and redeeming them in another. He had agents buying IRCs for him in other countries, exchange them for stamps worth more than he paid in yet another country, and then sell the stamps. Eventually, Ponzi began seeking out investors to take this scheme to a larger scale. He promised returns of 50 percent in 45 days or 100 percent in 90. Ponzi never really made an actual profit but paid investors with money he solicited from other investors.
With the evolution of technology, so did the Ponzi concept. In 2008, American financier Bernard Madoff was convicted for executing the largest Ponzi scheme in history. This heist involving falsified trading reports that showed he was turning a profit when, in fact, there wasn’t any.
Madoff was forced to forfeit $170 billion in assets and sentenced to 150 years in prison. His complex betrayal of countless investors spanning over five decades is evident by the voluminous paper trail alone in victim claims, likely pored over by an army of forensic financial investigators. His final account statements, consisting of millions of pages of fake trades and questionable accounting, indicate that his firm amassed $47 billion in so-called profit.
Don’t Be a Victim of Ponzi
Ponzi schemes throughout history victimized people from all fronts. Venture capitalists, religious organizations, celebrities, and social elite, among others, have lost fortunes as the schemes unraveled. Protect yourself with awareness so you can steer clear of these fraudulent money-making ventures. Here’s what you have to do to identify these schemes:
- Common Sense. If a financial venture sounds too good to be true, then it probably is. Remember, credible business organizations will never offer guaranteed returns. Attractive as they may be, know that guarantees of 8 percent to 12 percent annually are unrealistic because of market fluctuations. Thoughtful skepticism might just save you.
- Choose Wisely. Most Ponzi schemes are run by highly charismatic salesmen, many of whom might have impressive personal résumés but will likely manifest questionable professional ethics. Do not hesitate to inquire about accreditations or negative reviews or lawsuits that may have been filed against the individual or organization approaching you for investment.
- Ask Questions. Honest investment firms will typically retain reputable auditing firms. Shady ones will likely partner with easily influenced firms, which are generally small and obscure. It is your right to request visibility to their audited financial statements and reports.
- Initial Contact. Schemers typically establish initial contact through a cold call, a social network, or a local radio advertisement. Credible investments will usually market through national-scale channels or partnerships with well-established institutions.
- Are they Registered? Ponzi schemes will typically involve unregistered investments that do not have proof of scrutiny by financial regulators like the SEC or FCA.
As economies and livelihood across the globe continue to suffer from the current COVID-19 pandemic, Ponzi schemes continue to sprout up here and there, taking advantage of people desperate for income. Realize that unrealistic returns is a red flag and not a blessing from the heavens.
With Ponzi schemes, no one is really investing your money. Your “profit” is money taken from other investors like yourself. There might be a windfall in the beginning, sure. But this business structure is unreliable, vulnerable to eventual collapse once new investors stop coming in.