You’ve heard the stories of Bernie Madoff and how his victims lost all of the wealth they worked so hard to accumulate. You wonder how people could fall for his Ponzi scheme. But the sad truth is that it is very easy to fall prey to a Ponzi scheme.
The reason for this is because of greed. We want it all. And we try to find the easiest path to get there. Unfortunately, the easiest path is usually the one that makes someone else rich while we lose our money.
But there are things you can do to protect yourself. And the best thing you can do is to be able to spot a Ponzi scheme right away by being aware of the signs. Then you know to avoid it. So let’s get started with helping you to keep your money safe.
What Is A Ponzi Scheme?
Before we can spot a Ponzi scheme, we need to know exactly what one is. At its most basic level, a Ponzi scheme is an operation where one person promises high returns to investors. To achieve these high returns, the person running the scheme uses new investors money to pay the return for current investors.
For example, let’s say I was the leader of a scheme and am promising a return of 20% annually. I get you to sign up and you hand over your money for me to invest it for you. I then get your best friend to sign up.
I take his money and pay you your 20% return. When I sign up another person, I take their money and use it pay your friend his 20%. As more and more people sign up, the scam continues.
Understand though that the paying of earnings is all done on paper. I don’t physically give you your 20% each year. Instead I draft a statement of your account and show you that you made 20% even if you never did.
The reason this works is because most people will not sell out of an investment that is “earning” 20%. They will keep their money invested in the hopes of earning 20% in the coming years.
So while you and the other investors are excited about how much money you think you are making, I am taking all of your money and living life to the fullest.
How To Spot A Ponzi Scheme Instantly
Now that you know what a Ponzi scheme is, how do you protect yourself? Here are 5 signs to pay attention to:
#1. Pay attention to guaranteed returns. No trustworthy investment professional will ever guarantee or promise a return on investment. It just isn’t possible. So if someone is telling you that you will make 10% guaranteed, it is a huge red flag.
#2. Low risk. Related to the first point is the investment being low risk. While there are valid investments out there that are low risk, like treasury bonds, they tend to pay low returns. This is because risk and return are related. The riskier the investment, the higher the potential return. The lower the risk, the lower the return. So any offer of a high return and low or no risk is another warning sign.
#3. Complex investing strategy. Investing strategies are straightforward. You are invested in stocks, bonds, mutual funds or exchange traded funds. You might be invested in commodities like gold, oil or even real estate. The point is, you can understand the strategy. If you are offered a strategy you don’t understand, no matter how many times it is explained to you, that is a red flag.
#4. Paperwork. This one is often overlooked by many investors. Any reputable investment firm will produce and send you statements on a quarterly and annual basis. They also tend to be easy to understand. If you aren’t getting regular statements about your investment or the statement doesn’t make sense, this could be another warning signal.
#5. Trouble Withdrawing Money. If you are investing with a solid company and you want to take money out, the company will do as you wish without issue. But in a Ponzi scheme, many times there will be excuses why you can’t take your money out. Or, you might be convinced to stay invested to earn a higher return. These too are telltale signs of something fishy.
At the end of the day, greed is a powerful emotion. It gets us into trouble not only with our money but other areas of our lives as well. But talking specifically about money, be smart when investing.
Remember that risk and reward are always related. Also remember that the stock market historically has returned 8% annually to investors.
So if someone reaches out to you with a hot investment opportunity that is low risk and guarantees a 20% annual return, you should be doubtful from the start. Your best option is to look the other way because they are going to suck you in and tap into your greed to get you to give in and invest.
Hopefully you can resist the urge and keep your money safe by investing in reputable investments.