Investing

Types of Financial Scams: Ponzi Scheme

Types of Financial Scams: Ponzi Scheme
A Ponzi scheme, in simple terms, is a financial fraud that deals with a non-existent company. The confidence in the success of this ‘company’ is reassured through offering returns that other investments cannot guarantee to entice new investors in the form of short-term returns that are either abnormally high or unusually consistent. These returns are generated for the first/ older investors from the money invested by newer investors. There is never an actual product that the investors invest in. For most Ponzi schemes the only requirement is that when you join, you need to recruit a new investor as well. That’s the only way the returns can continuously flow. The name Ponzi comes from Charles Ponzi, 1920, when he developed this strategy. In later years, Bernie Madoff developed the same strategy and became the biggest Ponzi schemer who ran this business for over a period of 20 years. Both Charles Ponzi and Bernie Madoff were found guilty and arrested. Investors lost millions of dollars. Madoff Was sentenced to 150 years in prison for his fraudulent acts and died there in early 2021.

Now, you may be asking why were they arrested, this seems like a brilliant way to make money, especially if you can keep acquiring new investors. Unfortunately, this is only the case in a booming economy. When the economy isn't doing so well, there are fewer investors, and it becomes difficult to give the older investors the returns they are expecting. Ponzi schemes are based on words of promise and not actual products, hence why it is a system destined to collapse and found illegal by legal authorities.

Why do Ponzi schemes still exist?
Well, to start off with, people are hungry for money and will do anything to attain it. A Ponzi scheme only needs a few people to start it, and then it will continue to expand through referrals and recruitment. The main reason why people fall into the trap is because of positive testimonials that the manager of the scheme asked people directly to do. For someone who is not financially literate, the promise of greater returns seems exciting. Another reason for their existence is that not everyone is trying to create a business as large as Ponzi or Madoff. Some people just want enough capital to start a business or enough money to pay off debt. They only want to fulfill a short-term goal and exit the scheme as quickly as possible.

Why shouldn't you enter into a Ponzi scheme?

You shouldn’t invest in anything that is merely a hoax and there are no real products that you are investing in. No matter how big or small it is, there is no guarantee that there will always be an investor who comes in after you. There is no insurance or legal structure that you can fall onto should anything go south. And eventually, the money cycle will run out. Ponzi schemes are considered to be fraudulent investment management services and, therefore illegal. Your financial safety should be your top priority when you choose how to invest your money.

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