If something in life seems too good to be true, then it usually is.
This is definitely the case in investing, and sadly too many naïve but well-intentioned people are taken for a ride by shysters and fraudsters.
So-called Ponzi and Pyramid schemes are two ways that these con artists can entice people to invest their money in a system that, to the naked eye, appears to be legitimate and value-adding.
However, the real value in these scams flows through to the fraudster running the operation, and the investor is typically left out of pocket and cursing themselves for getting involved in such a set-up.
If you are concerned about being duped by a Ponzi or Pyramid scheme, this article details what each of these scams is, the differences between them, and how you can avoid a grift before parting with any of your hard-earned money.
What is a Ponzi scheme?
Named after Charles Ponzi, an American who ran a diabolical system that had actually been around for decades prior, a Ponzi scheme essentially sees capital invested into a fund flow upwards to the original founder.
Older investors are typically paid out profits made from new clients – unbeknown to them, who believe that the money is being made through legitimate business practices.
In the end, the Ponzi scheme creator typically ‘disappears’ and becomes non-contactable – running off with any money left in the scheme’s bank account.
Ponzi schemes promise big returns for investors through trading or high-interest investments, and the idea is for them to enjoy some early success – that way, more and more investors get involved, and the snowball effect takes hold.
When investors become suspicious, this is typically when Ponzi schemes unravel – usually leaving many out of pocket. When there’s not enough capital to pay out returns, this is when your ‘Ponzi’ will likely hit the road.
What is a Pyramid scheme?
Think about the shape of a pyramid – typically thick at the bottom and thin at the top.
This is a good way to describe pyramid schemes, which require investors and members to recruit new parties – charging them a fee to join the system.
That money flows up the pyramid to those at the top, with older investors getting their payday when they recruit a certain number of new ‘clients.’
With everybody paying a fee to join what is often termed ‘once in a lifetime’ investment opportunities, there’s typically only one person or a few getting richer – those at the top of the pyramid.
The differences between Ponzis and Pyramids
Typically, a Ponzi scheme promises big returns for investors, who, in the majority of cases, never arrive on the promised date.
With a Pyramid scheme, the focus is on recruitment – getting more and more paying investors to join.
There is no guarantee of a return from a Ponzi scheme, while in Pyramid schemes, a huge number of investors have to be recruited for those lower down the chain of command to yield any profit.
How to spot a Ponzi or Pyramid scheme
It’s actually pretty easy to spot a Pyramid scheme. Simply ask yourself why the person promising you riches is allowing you into their system – what do they stand to gain?
Ponzi schemes can be more difficult, because you may believe that you are investing in an individual with a market ‘edge’ or who has built some market-leading automated software.
How do you identify a Ponzi scheme?
In many countries, trading vehicles are subject to regulation and licensing requirements.
Reputable trading brokers and funds will be certified and given the green light to operate, and typically these have a clear presence online – read the reviews for OctaFX to see how a reputable firm goes about its business.
With Ponzi schemes, these will be unregulated, unlicensed, and typically their ‘headquarters’ are in some obscure overseas location – when you pry further, you will be hit with a brick wall.
Only invest with regulated trading operators.
What protection is there for your investment? Are you being promised ridiculously high returns that you know are very, very difficult to attain? Are you being ‘guaranteed’ a certain rate of ROI?
The truth is that investing is hard – really hard. Even achieving a return on your investment of 5% a year is a tremendous success, so ask yourself why your ‘Ponzi’ is able to do much better than that.
Investments carry risk, and supposed high return investments carry even more risk. Ask yourself, what are the credentials of this individual who is promising the earth?
Where’s my money?
The best way to test whether the investment vehicle you’re in is a Ponzi or not is to ask your investment lead to withdrawing your money.
The answer will be telling – they will say ‘yes, of course’, and that might just be a sign of a legitimate system.
If there is radio silence, or excuses are made as to why you can’t access your money, then that is the time to blow the whistle and exit the scheme as soon as possible.
Investment professionals and their firms are required to be licensed or registered by federal and state securities laws. Unlicensed individuals or unregistered firms might well be a strong indicator of a Ponzi scheme – the few exceptions usually being operations that were once legitimate but didn’t earn the expected returns.