What's a Ponzi Scheme?

Are you thinking about investing? Putting your money into securities is a great way to grow your money for retirement or other goals. However, investing isn't without its risks. There are many different types of investment risks, including market, economic and inflation risks.

One of the most dangerous investing risks is fraud. Scam artists use the promise of high returns to lure investors. The investments end up being based on half-truths or outright lies. A common fraud investors need to watch for is called a Ponzi scheme.

How's a Ponzi Scheme Set Up?

Scam artists aim to put potential investors about any investment risk. Still, investors are looking for a great return for their money. Investors are promised a certain investment will bring them a very high return with very little risk.

The initial investors of a Ponzi scheme actually receive high returns at the beginning. However, the problem is the source of the returns. The money doesn't come from the profits of the investment. It comes from new investors to the scheme. New investors pay the returns of the earlier investors.

What's the Problem with a Ponzi Scheme?

Investors get paid in a Ponzi scheme as long as new investors keep contributing to the investment. However, this constant flow of money can't last forever. There's not enough money if investors drop out or new investors don't join.

Many investors lose their money since there's no real investment to earn profits. Their money is just used to pay other investors or to pay the scam artists. A recent example of a Ponzi scheme involved a scam artist named Bernard L. Madoff. His scheme involved billions of dollars from thousands of investors. It's considered the largest Ponzi scheme in history.

Why's the Scheme Named Ponzi?

The scheme is named after Charles Ponzi, an Italian scam artist in the 1920s. He promised investors a great return in a postage stamp speculation investment. However, the investment was really a fraud. He used money from new investors to pay off earlier investors. Charles Ponzi made millions of dollars using this scheme. He was sentenced to prison for his crimes and later deported to Italy.

Is a Ponzi Scheme the Same as a Pyramid Scheme?

A Ponzi scheme is very similar to a pyramid scheme. Both schemes involve earlier members being paid with money from later members. However, there are a few common differences.

Pyramid schemes usually involve a product that's sold by the members themselves. They make money by finding other members to join. Ponzi schemes usually involve one seller who's promoting an investment promising high returns. The investors don't have to recruit other investors to make money.

Members of a pyramid scheme may never meet the original seller. They can join at any level of the pyramid. The seller in a Ponzi scheme usually communicates directly with the members.

Pyramid schemes are normally upfront that most of the money is coming from new members. Ponzi schemes are secretive. They never disclose the money is coming from new members and not investment profits.

What Are Some Warning Signs of a Ponzi Scheme?

Be careful and don't get involved in a Ponzi scheme. There are certain characteristics many of these schemes share. Some warning signs to look out for include:

  • Promised high returns with very little risk
  • Errors in investment documentation
  • Overly consistent returns
  • Unregistered investments
  • Have difficulty leaving an investment
  • Not receiving a scheduled payment
  • Overly complex investment strategies
  • Unlicensed sellers

Questions for Your Attorney

  • What types of investment risks do I need to watch out for while investing?
  • Who do I contact if I believe I am the victim of a Ponzi scheme?
  • Is there any way to get my money back from a Ponzi scheme?
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