How to spot a Ponzi scheme

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Want to get rich quick? Who doesn’t? This is the essential appeal behind the Ponzi scheme, an investment scam that repays investors from the investments made other investors rather than from profits. Eventually, the perpetrator of the Ponzi scheme runs out of new investors, however, and the whole scenario topples.

Ponzi scheme bait is typically an unrealistically high rate of short-term return. In one form or another, the scam has been around for centuries, but it owes its name to the fraudulent dealings of Charles Ponzi, an Italian con artist who perpetrated the swindle on a host of unsuspecting victims throughout the early 1920′s.

One of the basic laws of investment is that if an investment seems to be too good to be true, it’s best to avoid it. Here are some ways to spot Ponzi schemes, and protect yourself against them.

• Don’t be guided by greed. At any given time, the market has an average rate of return, but the more risk you assume in your investment, the higher that rate of return. Be very suspicious of any investment opportunity that offers you an “assured” return of abnormally high returns. Don’t let your reservations be quelled by the argument that other people are doing it either. If everyone you knew was jumping off a cliff to certain death, would you follow?

• Don’t allow yourself to be pressured into making an investment. Since Ponzi scheme organizers need your money to keep their fraudulent operations afloat, they will often try to pressure you with a false sense of urgency.

• Don’t be taken in by “tips.” One popular lure that many Ponzi scheme organizers use is “insider” information. Bernard Madoff, for example, told prospective victims that he was highly selective about the people to whom he offered his investment opportunities. If an investment opportunity isn’t open to anyone with the cash to invest in it, view it with a grain of salt.

• Although some Ponzi schemes use products or services as a front, most Ponzi scheme perpetrators are secretive about their business model. Bernard Madoff refused to allow investors access to his hedge fund’s financial statements. Avoid investments whose organizers refuse to divulge a basic business plan and strategy. A legitimate investment opportunity offers prospective investors some degree of transparency into its operations.

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• A popular form of the Ponzi scheme is the pyramid scheme in which an investor is promised rewards for recruiting more members. While not all multilevel marketing business plans are pyramid schemes, a great many of them are. Always use caution if you are approached to participate in a program where being paid or receiving a reward depends upon recruiting others.

• Never invest money with a money manager, business or organization without performing due diligence to make sure that company has a good track record for making profits. If a company is promoting a new or speculative product that is not a proven revenue generator, the company has an obligation to let prospective investors know this. If a company has no credibility, it’s best to avoid investing your money in it.

• The people promoting a money-making opportunity to you should also be credible. If an investment opportunity promoter has any history of fraud or financial controversy, it is best to sidestep that investment opportunity. It’s also a good idea to check the history of the company’s management team as well as any regulations governing the industry to ensure the business in which you’re considering investing is in compliance.