All you need to know about Ponzi Schemes

Introduction

I am sure most of you have heard of or even invested in a Ponzi scheme or pyramid scheme. A Ponzi scheme is a fraudulent investment scheme where investors are promised high returns with little or no risk. The scheme uses money from new investors to pay off existing investors thereby creating the illusion of a successful investment. Eventually, the scheme collapses when there are no new investors to provide money to pay off the old investors or when the creators of the scheme have amassed enough wealth or feel they are about to be discovered.

Case Study:

One of the largest Ponzi schemes in the world was perpetrated by МММ, a Russian company that orchestrated the scheme, in the 1990s. Estimates say about 5 to 10 million people lost their savings as a result of the Ponzi scheme. MMM and later MMM Global is believed to have operated in about 110 countries, making it one of the most sophisticated Ponzi Schemes.


In December 2008, Bernie Madoff, the former Nasdaq chairman and founder of the Wall Street firm Bernard L. Madoff Investment Securities LLC, admitted that the wealth management arm of his business was an elaborate multi-billion-dollar Ponzi scheme. In June 2009, Madoff was sentenced to 150 years in prison for his role in the Ponzi scheme.


The cases are numerous and we see and read of them every day. However, it seems that we keep falling into the same trap. Most investors, even though they are aware of the fraudulent nature of these schemes, still proceed to invest in the hope to profit from it by withdrawing their money before it collapses.

Ponzi schemes red flags

Here are some red flags to watch out for and remember An investment in knowledge pays the best interest Benjamin Franklin

High returns with little or no risk

In the real world high returns are often associated with high risk and a long-term investment horizon. Any investment that guarantees a high return with little risk is most like a Ponzi scheme.

However, US Treasury Bills and any other instrument guaranteed by a national government can guarantee a certain return and they have been known to have little or no risk. These instruments usually offer the lowest return compare to other asset classes like equities because they do not have any risk.

Overly consistent returns

Investment performance or returns tend to fluctuate over time. If an investment consistently makes money, regardless of the economic trend it may be too good to be true.

Unregistered investment vehicles

It’s always much safer to invest in investment vehicles that are registered. Investments can be registered with the Securities and Exchange Commission (SEC). Investments that are not registered are not subject to the same level of regulation as registered investments. This makes it more difficult for investors to get information about the investment vehicle and to protect themselves if something goes wrong.

Unlicensed investment advisors

Investment Advisors must be licensed by the state in which they operate. If a seller is not licensed, it is a red flag that they may be involved in a scam. It is also difficult to get compensation in the event that an unlicensed investment advisory firm has become bankrupt .

Secretive, complex strategies

Always make sure that you fully understand the investment strategies used in an investment. Always request the registration documents e.g. prospectus or trust deed. If you can’t understand how or where your money is being invested, it’s a red flag.

Pressure to invest

If you feel pressured to invest in something, it’s a red flag. Opportunities should not require pressure to invest, take your time to understand the investment.

If you see any of these red flags, it’s important to do your research, i.e., you can request the registration document or consult with a financial advisor before investing. It’s also important to remember that there is no such thing as a guaranteed investment or guaranteed return. Any investment involves some degree of risk.

Here are some tips for protecting yourself from Ponzi schemes

  • Do your research. Before investing in anything, be sure to do as much research as possible or get advice from professionals
  • Put everything in writing. This can be done through an investment policy statement(IPS)
  • Ask questions. If you don’t understand anything, please ask questions.
  • Be wary of high-pressure sales tactics. If you feel pressured to invest, it’s a red flag.
  • Report suspected scams to the SEC

Conclusion

If an investment is too good to be true, then it is probably not, that is why you need the help of professionals in your investment decision making process. After having earned your money, it is important to invest in sound assets rather that get rich quick Ponzi schemes.

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