If something seems too good to be true, then it probably is. All the more so if that something happens to be a get-rich-quick Ponzi scheme.
Although Ponzi schemes promise above-average returns, investors often end up losing their entire investment by giving in to their greed to earn higher returns.
Swindlers lure unsuspecting people with a promise of higher returns only to eventually abscond with the funds.
Ponzi Schemes
If something seems too good to be true, then it probably is. All the more so if that something happens to be a get-rich-quick Ponzi scheme. Although Ponzi schemes promise above-average returns, investors often end up losing their entire investment by giving in to their greed to earn higher returns.
Swindlers lure unsuspecting people with a promise of higher returns only to eventually abscond with the funds.
What Is a Ponzi Scheme?
A Ponzi scheme is an investment fraud where a fraudster collects money from people with a promise of higher than the usual market rate returns. A Ponzi scheme involves circulation of the capital instead of the distribution of profits. Such
The principal investment by subsequent investors is given as a payout to the old investors. This type of investment is not sustainable because for it to continue to operate, there has to be a constant stream of new investors. Scheme operators often end up using cash reserves to give payouts to existing investors when they don’t find new investors.
A Ponzi scheme is an investment fraud because the operators of such schemes don’t actually intend to invest their investors’ money in any legitimate investment option or give long-term payouts to their investors.
A Brief History of the Ponzi Scheme:
The Ponzi scheme gets its name from
Ponzi convinced people that he would buy postal-reply coupons at a discounted rate in a foreign country and then sell them at face value in the U.S., thereby earning great profits. Postal-reply coupons were coupons that were sent along with a letter from a foreign country, which would enable the recipient of the home country to write back to the sender without having to buy foreign postage stamps.
Postal-reply coupons could be exchanged for a foreign stamp without any monetary transaction. This was done to ensure that the person who had to reply to the letter didn’t have to worry about currency exchange rates while buying postage stamps. They simply had to exchange coupons for stamps.
The scheme lasted for over a year before falling apart in 1920. His investors lost about $20 million when an article in the Post exposed Ponzi and his criminal activities. Charles Ponzi received a 5 years prison sentence for mail fraud in 1920.
There were several people before Ponzi, like Sarah Howe, William Miller, etc., and several others after him like Ivar Kreuger, Bernard Madoff, etc., who masterminded these schemes that swindled millions of dollars from unsuspecting investors.
Ponzi Scheme Vs. Pyramid Scheme:
Although a Ponzi scheme is very similar to a Pyramid scheme, the key difference between the two schemes is that in a Pyramid scheme, the existing investors are actively involved in recruiting new investors. In a Ponzi scheme, however, there is no direct participation of old investors in recruiting new investors.
In a Ponzi scheme, all transactions are handled by scheme operators. In essence, a Ponzi scheme is an investment fraud and a Pyramid scheme is disguised as a Multi-Level Marketing (MLM) business.
Another difference between a Ponzi scheme and a Pyramid scheme is that there is no specific product or service in a Ponzi scheme. However, in a Pyramid scheme, the scheme operators offer either a single product or service or a set of products and services from which they claim to make tremendous profits. The operators lure more and more people with a promise of a profit.
However, if the scheme fails to attract new investors, it falls apart leading to people losing all the money they invested.
Red Flags to Watch Out For:
Here are red flags investors should watch out for:
- Problematic paperwork: In a Ponzi scheme, the investors aren’t usually given access to any investment-related documentation. Be it prospectus or account statements, investors are usually unaware of what happens to their money or where the operators have invested it. Operators keep investors in the dark about all investment-related decisions.
- Not registered: Ponzi scheme operators often claim that their investment plan is exempt from registration. An operator who claims that their investment plan doesn’t need to be registered with the Securities and Exchange Commission (SEC) or other regulators should not be trusted.
- Pressure tactics: Most of the Ponzi scheme operators can be charismatic charlatans who can convince investors that their scheme is a limited-entry offer reserved only for a select few. They use pressure tactics to convince investors to make up their minds sooner rather than later. Operators usually convince investors that if they make a late decision, then they’ll lose out on the opportunity to make tons of money. This fear often leads people to make uninformed decisions.
- No risk, high returns: There is always some risk associated with investing. Any investment plan that claims otherwise should not be trusted. Also, it’s practically impossible for investors to gain above-average returns without having to bear any risk.
- Consistent returns: All investment plans are subject to market risk. If a scheme offers payout or dividend consistently irrespective of market fluctuations, then such a scheme is not sustainable and will fall apart sooner or later.
- Unclear organizational structure: Most Ponzi schemes don’t have a proper organizational structure. Investors should thoroughly research and enquire about the people operating the scheme and their backgrounds. Observational Learning is a big prospective learning method for the same. They should insist on talking to the board of directors or anyone who is a key member of the board and ask them questions about the investment plan before investing.
Steps to Take to Avoid Falling Prey to a Ponzi Scheme:
Investors should be extra cautious before trusting someone with their hard-earned money. To avoid walking into a trap, prospective investors should:
- Not cave in: It’s never wise to fall for pressure tactics. It’s always important to take enough and more time before making any financial decision.
- Ask questions: It’s important to ask the right questions to people in authority about where they plan to invest their investors’ money. People should ask questions about registration, documentation, and everything else that is necessary to make an investment legitimate.
- Look for reviews online: With the dawn of the Internet, it’s easier to differentiate a legitimate investment from an illegitimate one. Prospective investors can research an investment scheme on the Internet to check what others are saying about that scheme. If there are more negative reviews than positive, then it makes sense to stay away from such schemes.
- Consult a financial advisor: It helps to take a second opinion from a financial advisor. Financial advisors have the expertise required to offer appropriate guidance. They also have access to industry inside information which equips them with the necessary knowledge to help investors make a decision.
- Exercise caution: This can’t be emphasized enough. It’s better to be safe than sorry, always. Investors should exercise caution and not fall for marketing gimmicks. It’s always better to reach out to experts before investing.
With the dawn of the Internet, it’s now easier to reach more people to pitch a scheme to. People should be careful about who they give their time to and also discourage internet or telemarketing solicitations.
Anyone who is keen to invest should do so through proper channels. It helps to remember that almost all get-rich-quick schemes are a trap irrespective of how appealing they seem to be.
References: