Fonzie was no Ponzi
Understand these un-cool schemes and how to avoid them.
Laura Adams, MBA
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Fonzie was no Ponzi
This show is about Ponzi schemes and tips to help you identify these incredibly risky investments.
What’s a Ponzi Scheme?
Fonzie is a cool guy from the classic sitcom Happy Days. Ponzi was a very un-cool guy from the 1920s who bilked investors out of millions using an illegal business model. Charles Ponzi didn’t actually invent the scheme, but he certainly became notorious for it. He was buying international postal reply coupons at a discount and then redeeming them for U.S. postage stamps at a higher value. He promised investors amazing profits that were supposed to come from this legitimate business. However, this wasn’t where the investment money was really going.
I’m sure you’re familiar with one of the latest and biggest Ponzi schemes in history, perpetrated by Bernard Madoff. Yes, he’s the guy who made off with over 50 billion dollars of his investors’ (or should I say victims’?) money. “Ponzi scheme” is now a term used for any fraudulent operation that promises a high return to investors. The fraudulent part comes from the fact that the returns are not generated by profit from legitimate investments. The high returns are paid to investors out of money received from new investors. So the new money is what makes the promised high returns to earlier investors possible.
This house of cards holds up only as long as there’s a steady stream of new investors injecting money into the operation. Ponzis eventually collapse under their own weight when they get so big that the inflow of new money can’t cover all the promised payouts. And as more investors get involved, the chance that someone will alert the authorities increases. Some Ponzis, such as Madoff’s, are even registered with the SEC.
Identify Ponzis
No two Ponzis are exactly alike. This is why they can be very difficult to identify, even for sophisticated investors. Heck, even the SEC and some big-time folks on Wall Street got duped by Madoff. His investment method was marketed as being too complicated for most people to understand. We now know that his real method was nothing more than the exploitation of his upper-class social networks. People get sucked into Ponzi schemes because the promise of extraordinarily high returns can cloud even the most prudent investor’s good judgment. The financial meltdown of 2008 left Madoff exposed as investors started demanding cash that he couldn’t possibly return.
Ponzi Danger Signs
Here are some bright red flags to watch out for that may be signs of a Ponzi scheme:
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The promise of an unusually high or consistent return on investment. This is almost impossible to achieve from legitimate investments because their value fluctuates over time. I’ve heard that Madoff’s investments paid 10% to 12% per year. This isn’t a crazy return, but it is impossible to maintain for decades during good and bad financial markets.
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One central person who has a top secret investing formula. Any investment that relies on the expertise of one person is suspicious.
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A lack of transparency about underlying investments. There’s no substitute for detailed financial information. Protect yourself by requesting statements that have been audited by a reputable accounting firm.
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An urgency to recruit new investors. High-pressure sales tactics may be used over the phone or in person. Be very wary of unsolicited investment offers you may find in a fax, e-mail, or Internet posting.
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Persuasion to invest targeted toward religious or affinity groups. Con men are so named because they’re out to gain your confidence. They try to deceive people who don’t have much financial knowledge or won’t ask many questions.
Do Research Before Investing
Anything that sounds too good to be true, well, you know the rest. All investments carry some level of risk, especially those offering high returns. But it’s always a good idea to do some independent research before investing your money. Compare promised returns with the current returns that stock indices are receiving. And be sure to understand a company’s business model and its products or services before investing. Being an educated investor is your best defense against falling prey to fraud.
For more information about scams and how to recognize them, see my episodes on investment fraud, job scams, identity thieves, and common internet scams.
Administrative
Are you looking for successful strategies to save and invest for a secure future, even during market volatility? Check out my new audiobook, Money Girl’s Guide to Retirement Planning. Find it on iTunes and Audible.com.
I’m glad you’re listening. Chi-Ching, that’s all for now, courtesy of Money Girl, your guide to a richer life.
“I went looking for trouble and I found it.” – Charles Ponzi
Scared Businessman image courtesy of Shutterstock
About the Author
Laura Adams received an MBA from the University of Florida. She’s an award-winning personal finance author, speaker, and consumer advocate who is a frequent, trusted source for the national media. Money-Smart Solopreneur: A Personal Finance System for Freelancers, Entrepreneurs, and Side-Hustlers is her newest title. Laura’s previous book, Debt-Free Blueprint: How to Get Out of Debt and Build a Financial Life You Love, was an Amazon #1 New Release. Do you have a money question? Call the Money Girl listener line at 302-364-0308. Your question could be featured on the show.