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What the Heck is a Ponzi Scheme?

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Danielle Hoston: So... what exactly is a Ponzi scheme? In the simplest of terms, a "Ponzi scheme" is elaborate, high stakes system of robbing Peter to pay Paul. Ponzi schemes rely heavily on constant streams of new investor money to pay back old investors who are then encouraged to reinvest their money until the scheme eventually collapses. When the new investors run dry, so does the schemer's ability to pay out profits to previous investors. In the end, the schemer remains wealthy (and goes to jail as in the case of Bernie Madoff) and many lives are ruined.

woman protecting her money

Here are my tips to protect you and your family from these types of schemes:

  • If it sounds too good to be true, IT IS! There's really no other way to say it. Ponzi schemes and the like often offer short term, far above market returns that are sold to people who do not typically invest.

  • Ask an expert. Ponzi schemes can come in many different packages. If you are being offered the opportunity to invest in real estate, track down a real estate investor (that has NOT invested in the proposed investment) and ask what typical returns are and what other important information should be ascertained before investing.

  • Read the fine print. Unfortunately, many of us are more critical of a restaurant receipt than we are of the promise of great riches from people that we think are trustworthy. Keep in mind that whenever you are being offered a high return, you can rest assured that the risk is at least as high.

  • Don't put all of your eggs in one basket. If losing the money you intend to invest could potentially destroy you or your family's financial welfare, you are investing too much. Find other investments to offset your exposure.

  • Check licenses. All sales of securities and/or investments require licenses. Don't allow your relationship with the schemer, the success of the person who referred you, or the promise of a worry-free, luxurious life prevent you from doing your homework.

  • Don't re-invest. Some of you will not be able to resist the urge to try out risky investments. If you should be lucky enough to get paid off initially, do yourself a favor: Take the "win" and walk away. You may have out-schemed the schemer. Don't press your luck.

Drug dealers are known for "giving the first one free" in order to get their victims hooked.

Likewise, these con artists capitalize on the reinvestment of their victim's winnings until they are lost. I've had several close friends, clients, and associates who have lost hundreds of thousands of dollars to schemers of all types. They could have saved themselves a world of grief if they had followed these few tips. You can save yourself from being added to a list like this by remembering that there is NO SUCH THING as a "get rich quick" scheme that is likely or legal.

Momlogic wants to know: Have you been schemed? Should our government have anti-Ponzi scheme laws?

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5 comments so far | Post a comment now
ivar March 13, 2009, 3:51 PM

I have worked at firms considered to be reputable, like Smith Barney. While they aren’t outright stealing your money, they are selling you bad “products” in order to make a lot of commissions. Paying management fees are also a complete waste of money as there isn’t a single managed mutual fund in existence with a track record that justifies paying their fees. If you think I’m just some disgruntled former employee, then, please read The Battle for Capitalism by John Bogle.

Charles March 13, 2009, 3:53 PM

Social Security is the biggest Ponzi scheme there is, and we all pay into it because the Fed Govt. says so.

Selene March 14, 2009, 1:26 PM

That is very interesting. Thank you so much for that info.

Jerwayne Ellis March 16, 2009, 3:00 PM

This is going to sound crazy but I honestly believe that they should be treated the same as drug dealers. Perhaps if the charges were harsher then it would scare people away from running this schemes.

Mr. Charming May 7, 2009, 12:12 AM

Based on this description, Ponzi schemes seem destined for failure and the end result being you are tossed in Jail, I am confused as to why would any criminal of sound mind attempt a ponzi scheme given its lack of an exit strategy…

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