Ever wanted a get-rich-quick scheme that let you live fast and crash and burn even faster? Then a Ponzi scheme is right for you!
In all seriousness, Ponzi schemes are illegal in many countries and ultimately end with significant financial losses, particularly to those who put money into them. Being lured into a Ponzi scheme may seem a bit far-fetched when you’re on the outside looking in, but it’s vastly different when you’re the one being conned.
So what exactly is a Ponzi scheme and how does it work?
How A Ponzi Scheme Works
A Ponzi scheme is an investment scam that is run by a single person. The scammer or operator convinces people to invest in a non-existent business and continues as long as the operator can get more people to invest. The previous investors are paid off with the investments from newer investors and that chain continues until there are no new investors, at this point, the Ponzi scheme collapses.
Difference Between A Ponzi Scheme And A Pyramid Scheme
On paper and several sources online make it sound like a Ponzi scheme and a pyramid scheme are somehow the same. While they have strikingly similar concepts, there are a few things that separate them.
Similarities
- Both require new investors for the cash to keep flowing
- Both have a central person the money goes to
- Both promise exceedingly high returns on their investments (ROI)
Differences
- Ponzi schemes are run by a single controlling party who gets rich off other investors
- Pyramid schemes give their “investors” the chance to make money by recruiting other “investors”
- Ponzi schemes are founded on a non-existent business
- Pyramid schemes tend to have a product or service that is sold but require an investor to pay their recruiter a fee to do so
The Origins Of The Ponzi Scheme
The Ponzi scheme is actually named after its creator, Charles Ponzi. Charles was an Italian immigrant who convinced thousands of people to “invest” with him, promising exorbitant returns, sometimes even promising 50% interest in just 90 days. His run started in January 1920 and lasted a little less than a year before being caught.
With his charisma, Charles Ponzi was able to swindle a wide range of people. You’d imagine only people described as “suckers” would fall for Ponzi’s scheme, such as down-on-their-luck immigrants looking to make it big, but police, politicians, bankers, and even a priest fell victim to his charm. Charles didn’t discriminate when it came to making money. In fact, his silver tongue and the “results” of his “investment plan” worked so well, his investors chose to reinvest their earnings instead of cashing out. Before he was finally caught, it was estimated that he was bringing in about a million dollars a day.
A Modern Ponzi Scheme
In recent history, there’s been another Ponzi scheme that made the news. Back in 2008, Bernard Madoff was convicted and sentenced to 150 years in prison. Madoff is infamous for committing the largest Ponzi scheme in history, with an estimated runtime of 17 or more years and involving billions of dollars.
Just as Charles Ponzi always brushed off the question of how the money was made, Madoff also claimed that explaining it would ruin the investment as competitors would steal trade secrets. Aside from the duration the scheme ran for and the amount of money involved, another scary fact was that Madoff had a chair seat within the Nasdaq and was also a pioneer in electronic trading. He had official qualifications to make people believe he knew what he was doing.
How To Avoid Being Caught In A Ponzi Scheme
Have you ever heard the saying, “if it’s too good to be true, it probably is”? That’s the case with Ponzi schemes. While they can be difficult to spot, here are a couple of warning signs you can look out for:
- Unusually high return with little to no risk
- Increased pressure to invest quickly
- Investment strategies are kept secret and aren’t disclosed to anyone
- Difficult to get information about your investment
Going back to things being too good to be true, exercise a level of caution when something sounds like a get-rich-quick scheme. Make sure to do your own research before investing in something. Don’t ever blindly go into something just because someone was convincing during a single or couple of meetings. It also helps to get outside opinions, a financial advisor, for example, can help determine the credibility of certain investments.
Investing in only well-established and regulated companies is another way to avoid being scammed. Unsolicited emails, calls, or in-person inquiries should be taken seriously and carefully assessed before making any sort of commitment.
Doing any of these will lower your chances of being caught in a Ponzi scheme. If you want to make sure you’re not falling for one, do everything you can to prevent being scammed, approach investments cautiously, do your own research, seek outside opinions, and stay vigilant.
The Wrap Up
Ponzi schemes are illegal and can cause significant financial losses. It’s important to be aware of these types of scams and to be skeptical of investments that seem too good to be true. By understanding how Ponzi schemes work, how they came to be, and how to avoid them, you can protect yourself from ever being a victim of one.