Ponzi schemes haven't changed alot since Charles Ponzi's postage stamp scheme in the 1920's. So why do people keep falling for them? Because the promise of riches is simply too good to pass up. But that promise is an empty one.
Ponzi schemes are especially popular during times of low interest rates or uncertain markets, like we have today. But if something sounds too good to be true, it often is. Here are five signs to look for.
1. Unusually high returns with little or no risk
All investments have ups and downs, and anything earning a consistent return, even in a down market is a red flag. Successful investors might beat the market some of the time, but not all the time. Ponzi schemes often have little variation in the return for year to year, despite market variations. If you are earning twenty percent when markets are declining, there's a chance it might not be real. These investment vehicles are often touted as "little" or "no risk", often giving some vague explanation about hedging risk. A key sign is offering a guaranteed minimum return in a short period of time, or a minimum annual return. Beware.
2. Unregistered Investments
Run, don't walk away from unregistered investments. Registered investments have the protection and scrutiny of securities regulators and are a source of information on a company's products, servies, managment and finances. Ask yourself one question- why is this investment unregistered? What are they trying to hide?
3. Unlicensed sellers
Most Ponzi schemes involve unlicensed sellers, simply because they need to stay under the radar to perpetuate their scheme.
4. Secretive or complex strategies
If an investment can't be explained well enough for you to understand, don't buy it. At best it is meant for a more sophisticated investor. At worst, and more likely, the seller is trying to obscure the investment because it is a fraud. Never invest in something you don't understand.
5. Issues with paperwork
Never invest in anything without a prospectus. A prospectus details the nature of the investment, risks, strategy, and rights and obligations of all parties. No paperwork? Forget it.
Other signs are errors or strange transactions on account statements, or lack of information when you request it. Excuses and delays mean there are problems.
In my next post I'll look at tell-tale signs a Ponzi scheme is about to go bust.
Author of Exit Strategy