What's a Ponzi Scheme?

Investments are rarely without risk – and it’s not just the basic risk. Investing also brings the risk of falling prey to a scam. 

Investment scams can include promises of high returns for super-low investments that never materialize, scammers posing as financial planners offering useless advice for a hefty fee and illegal securities offered as IRA investments. However, the most common investment scam is the Ponzi scheme. 

Let’s take a closer look at this scam and how you can avoid falling victim.

What is a Ponzi scheme?

In a Ponzi scheme, the orchestrator promises high returns, often through a fictitious investment opportunity or business venture. Instead of using investments to generate profit, though, the scammer uses these funds to pay returns to prior investors. The scheme grows, with more investors joining, and the scammers at the top of the pyramid making the most money. Eventually, it all comes toppling down, with investors losing tons of money. 

How to spot a Ponzi scheme

Watch for these red flags of a Ponzi scheme:

1. Unrealistic returns: Ponzi schemes promise consistently high returns that far exceed market averages and legitimate investment opportunities. 
2. Lack of transparency: Scammers may provide vague or evasive explanations regarding the source of returns or underlying investment strategy, making it difficult for investors to assess the legitimacy of the opportunity.
3. Promises of exclusivity: Ponzi schemes often use tactics like exclusivity or invitation-only to create a sense of privilege and allure. 
4. Pressure to recruit new investors: If an investment opportunity requires you to recruit friends and family members as new participants, you’ve likely stumbled upon a Ponzi scheme.
5. Unregistered or unlicensed operators: Legitimate investment professionals and firms are registered or licensed with regulatory authorities and adhere to strict compliance standards.
6. Lack of audited financial statements: Ponzi schemes generally lack verifiable financial records or provide falsified documentation to create the illusion of credibility.

Protect yourself from Ponzi schemes

Ponzi schemes are fairly common, but with a little bit of knowledge and awareness, you can prevent yourself from falling victim. Here’s how to protect yourself from Ponzi schemes:

• Research every investment opportunity carefully, including the background of the individuals or companies involved and the legitimacy of the investment strategy.
• Consult a trusted financial advisor or investment professional before making investment decisions. 
• Diversify your investments across different asset classes, industries and geographical regions. 
• Stay informed and educate yourself about common investment scams and warning signs of fraudulent activity. 

Stay alert, and stay safe!