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How to Avoid Getting Duped in a Ponzi Scheme

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How to Avoid Getting Duped in a Ponzi Scheme

Nearly a decade after Bernard L. Madoff made off with some $64 billion of investors’ money in one of the biggest Ponzi schemes in U.S. history, people are still falling for scams and losing the savings they worked a lifetime to build.

You’ve heard the term Ponzi scheme, but maybe you don’t know exactly what it is and how it works. Basically, it’s an investment fraud that pays existing investors with funds collected from new investors. There’s usually the “guarantee” of high returns with little or no risk. In reality, often the fraudsters never even invest the money. Rather, they use it to pay earlier investors, put some in their pockets and continue playing the game, finding new pawns to ensure cash flow.

This can go until they can no longer find people to dupe, too many folks cash out, or the crooks get busted by authorities. In case you’re wondering why it’s called a Ponzi scheme, it’s named after Charles Ponzi, who duped thousands of New England residents into investing in a postage stamp speculation scheme back in the 1920s.

What are red flags?

Truth is, sometimes the handwriting is on the wall, but you just don’t recognize what spells T-R-O-U-B-L-E.

“The biggest tip that can help consumers avoid Ponzi schemes is to understand the relationship between risk and return,” says Jacob Lumby, a certified financial planner and founder of cashcowcouple.com. ”The entire investment universe is founded on the relationship between risk and return.”

If an investment promises a higher expected return, you should expect that investment to carry some risk and vice versa. For example, explains Lumby, savings accounts pay very little interest because they are virtually risk-free. On the other hand, the stock market has provided an average annual return of roughly 10 percent over the last century, but in return for that higher average returns, investors had to endure periods of severe volatility that may have cost them money. The higher expected return is correlated with the risk involved.

A key feature of many Ponzi schemes is that an investment adviser promises all the rewards but mentions no risk.

“If a Ponzi scheme offers an outlandish guaranteed return, while also promising to be without risk, that is a major red flag,” Lumby says.“There are no free lunches in the investment world, and if something sounds too good to be true, it probably is.”

The U.S. Securities and Exchange Commission offers some insights on warning signs:

Overly consistent returns. That just doesn’t make sense, does it? It’s like someone hitting home runs every trip to the plate. Steroids perhaps? Something’s up.

Secrecy about how your money’s invested. The same goes for an adviser who is overly vague if you ask questions about where your money is going, or he or she explains it in a way that is so complex it makes your head spin. The fraudster may be a little shaky in presentation and mostly stresses that this investment is “the next big thing” that “few people know about.” If you can’t understand or can’t get complete information, don’t assume the adviser simply knows more than you do. Keep asking questions.

Shoddy paperwork — or none at all. Read those investment reports closely; don’t just leave them in the pile of junk mail. And get nervous if the paperwork seems shoddy. According to the SEC, account statement errors may be a sign that funds are not invested as promised. Be suspicious, too, if you don’t get paid when you’re supposed to, encounter obstacles when you try to cash out, or are offered even higher returns for staying in the game when you decide you want out.

Expect all sorts of tricks

Be mindful too, that Ponzi schemes come in many varieties, and don’t just involve stocks. Take, for example Bitcoin. There was a case, SEC v. Shavers, where the organizer of an alleged Ponzi scheme advertised a Bitcoin “investment opportunity” in an online Bitcoin forum.

Investors were allegedly promised up to 7 percent interest per week, and were told that the invested funds would be used for Bitcoin arbitrage activities in order to generate the returns. Instead, investments were allegedly used to pay existing investors and exchanged into U.S. dollars to pay the organizer’s personal expenses.

Even plain-vanilla investments like certificates of deposit can be used by scammers.

Protect yourself

A good rule to follow is to always diversify your investments. If any advisers is asking you to put all your eggs into one “sure thing” investment, walk away. The point of diversification is that all your assets aren’t tied up in one thing, which would leave them highly susceptible to any volatility.

And if you don’t want to get played, stay alert. Listen to your instinct. Trust your gut. If something doesn’t feel right, you’re likely not wrong, so don’t let greed get in the way of wisdom. Be paranoid: Somebody may be out to get your cash.

Comments
pua
pua   |     |   Comment #1
I've always wondered about that T.J. Young TV commercial that says if you invest with him, your investment will go up when the market goes up but will never go down when the market goes down. Here's the 30-second ad:
https://www.ispot.tv/ad/79Hh/ty-j-young-never-lose-money
Concerned
Concerned   |     |   Comment #4
The stock market IS a PONZI SCHEME that goes up every day so you don't have to worry about it going down!
fat and happy
fat and happy   |     |   Comment #2
i have never found diversification to be OF ANY VALUE, ZIP ZERO NADA........IT PROVES YOU REALLY DON'T KNOW WHAT YOU ARE DOING, YOU ARE GUESSTIMATING,,LIKE PLAYING BLACK AND RED ON THE ROULETTE WHEEL,,,, IF you are going to hedge your bet,,,,,THEN WHY BET AT ALL,,,,,that's where money in the bank proved out,,,,but with the wall street LAPDOGS in charge at the fed....it proves out to be not much. HEY ABOUT THAT GENERAL HYTEN MOUTHING OFF ABOUT ILLEGAL ORDERS FROM TRUMP.....if YOUR HERO TRUMP does not censure this guy or fire him,,,,,IT WILL PROVE ONE THING,,,,TRUMP HAS NO CONTROL OVER THE MILITARY WHATSOEVER,,,,,but as I have always said,,,,TRUMP IS IN CHARGE OF THE MONEY AND THE MONEYED AND HIS SOLE JOB IS TO TAKE CARE OF IT AND THEM AND HIMSELF TO THE ROYAL,,,,,. GOD CREATED REPUBLICANS TO CREATE TAX POLICY THAT MAKES THE CORPORATIONS AND THE TOP 5 PERCENT REGARDLESS OF THEIR POLITICS, FAT AND HAPPY.
#7 - This comment has been removed for violating our comment policy.
#9 - This comment has been removed for violating our comment policy.
deplorable 1
deplorable 1   |     |   Comment #15
@fat and happy: I agree with you to some extent as many people are overly diversified to the point of just mirroring the overall market. You do need some diversification though even if that diversification is just different stocks within the same sector of the market. Also diversification could mean having some money in FDIC/NCUA protected CD's vs. stocks, bonds, mutual funds. Without any type of diversification you are literally putting all your eggs in one basket. Trump's policies are helping me a great deal and I'm far far from the top 5%. Take off the political blinders once in a while and you will find that the view isn't all that bad.
#16 - This comment has been removed for violating our comment policy.
Rickny
Rickny   |     |   Comment #3
Social Security a Ponzi scheme?
Nothing
Nothing   |     |   Comment #5
Are you saying any program that takes money, e.g. employment taxes, up front? Insurance of all types meets that definition. What is your point?
triangular
triangular   |     |   Comment #6
It's not about upfront but about whether the system systematically pays out more than it brings in, and SS is such a system. The Fed Gov't probably qualifies too--it's just too darn easy for politicians to solve the problems of today by adding debt for younger (and even unborn) people to pay off later.
Bogie
Bogie   |     |   Comment #8
I can see why some people would consider our Social Security System a Ponzi scheme. The SS trust fund doesn't make any money, while it pays out to current recipients and depends upon cash coming in from future taxpayers.

Sure, the U.S. Treasury Dept. "borrowed" all the money that was in the SS trust fund, but it will never be paid back. Even when we have a "balanced budget", which is very rare, all it means is that we broke even for that particular year. The trillions in U.S. debt still remain and continues to mount. Our politicians, both parties, have lost sight of fiscal responsibility in Washington.
deplorable 1
deplorable 1   |     |   Comment #12
Social Security is not only a Ponzi scheme but it is one that the government forces you to participate in! There is no way to avoid it. It pays the current recipients with the taxes from the new crop of employees. We are 20 trillion in debt folks there is no SS trust fund that money was spend decades ago. This is why they always have to "fix" it by reducing benefits, increasing taxes or increasing the age at which you can collect and then to add insult to injury making it taxable to boot.(a tax on a tax)
If you watch the tv show American greed SS reminds me of the guy who is trying to keep his ponzi scheme going by suckering in new investors just before he packs his bags for South America.
Jennifer
Jennifer   |     |   Comment #10
Just walk away. Renee did it in that 60's song and you can do it too!
dowahdideedideedodiddydo
dowahdideedideedodiddydo   |     |   Comment #11
are you jennifer juniper?
deplorable 1
deplorable 1   |     |   Comment #13
The best way to protect yourself from being the victim of a ponzi scheme is to get educated and do your own investing. Don't trust anyone with your money and yes this includes full service brokers as well. The simple truth of the matter is that nobody is going to be more careful with your money than you are no matter how much you pay them. Just look at all the former celebrities and lottery winners who used to be rich until they decided to let someone else "handle" their money.
Nothing
Nothing   |     |   Comment #14
Ask for audited independent financials and independent persons to contact as a starting point. “If too good, it is too good!”
Bozo
Bozo   |     |   Comment #19
Deplorable 1 (re comment #13), an interesting show on TV is "American Greed" (I think it's on CNBC on Sunday night, but my memory is fuzzy). The show profiles many Ponzi schemes. Turns out, most are related to "affinity groups". Madoff was classic, as he preyed on co-religionists. The predators focus on others who could never suspect one of "their own" would dupe them.
deplorable 1
deplorable 1   |     |   Comment #20
@Bozo: I notice one common theme among every single victim of all the ponzi schemes on American Greed. All of these folks didn't do their own investing. They either relied on stock brokers, family, friends, their church or other organization for financial advice. None of them even though they may have had substantial wealth were very versed in investing or fully understood even what they were investing in. None of them did their due diligence. I find the show fascinating though right up there with "masterminds". It would be a useful tool for people to understand what to avoid when investing.
Bozo
Bozo   |     |   Comment #21
Deplorable 1, my wife finds "American Greed" mesmerizing. She cannot believe how folks could be so duped. I asked her "what is the closest affinity group"? She replied, "well, family, of course". Point being, "friends and family" are the red flags in most Ponzi schemes. Then, I asked her, what was the biggest IPO single loss (from an investment standpoint) we ever suffered? Answer: "well, I guess that "friends and family" investment back in our daughter's company's IPO back in the dot-com era". Yup, friends and neighbors, it was a Ponzi. And we were the Ponzettes.
Bozo
Bozo   |     |   Comment #22
Clarification: it was not our daughter's company. She was but an employee.
Nothing
Nothing   |     |   Comment #23
Should have listened to your investment banker son?
Bozo
Bozo   |     |   Comment #24
Nothing (re comment # 23), son was totally ambivalent on the IPO. Mind you, this was back in the pre-dot com crash.
Nothing
Nothing   |     |   Comment #25
How is this on point when u were originally talking about dot com era and now talking about pre-dot com? Remember you state “we”. Stay focused
Smokeboat
Smokeboat   |     |   Comment #17
You got to know when to say no.
Nothing
Nothing   |     |   Comment #18
And, how do "you" know when to say no? Most people don't know what they don't know! Part of Negotiation 101, "how do 'you' cover/address the unknowns?"
#26 - This comment has been removed for violating our comment policy.
what planet is this?
what planet is this?   |     |   Comment #27
fiduciary, full disclosure, telling customers about deal killer details,,,,,,,these are ancient customs long forgotten in the banking world,,,,,AND WHY WOULD ANYBODY MOUSE CLICK EVEN A DOLLAR TO A DUST BOWL AMERICA BANK OR CU FOR A BLUE LIGHT SPECIAL,,,,,when all you get is a call center cs'er because you are half a country away from their brick mortar even if they have one???,,,,,de novo banks are popping up all over,,,better than a coffee house or saloon and every schilltz head is opening up a net bank....it's tulip time in america.