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How To Recognize and Avoid Ponzi Schemes

Learn to tell the difference between getting in on a legitimate investment opportunity and becoming a pawn in somebody's shady plot.

Instructions

  • TIP: Always beware of companies that require you to bring in new investors in order to recoup your initial investment and start making profits.
  • Step 1: Check with the Securities and Exchange Commission or your state's Office of Financial Regulation to see if the person who approached you is licensed and if the investment is registered. If it's a foreign investment, check with the International Organization of Securities Commissions.
  • FACT: In 2008, Bernard Madoff was accused of bilking investors out of $50 billion in an elaborate Ponzi scheme.
  • Step 2: Watch out for Ponzi scheme's cousin – the Pyramid scheme. This con gets people to buy into a distributorship where they market a particular product. The catch? The real money is made by bringing in new owners and taking a cut of their investment. Only a few people who got in at the start make money off all those who join later.
  • Step 3: Be wary of the promise of a tidy monthly interest payment. Many Ponzi schemes use that promise as bait.
  • Step 4: Understand how a Ponzi scheme works: The mastermind collects money from investors for a nonexistent venture, and early investors are paid so-called interest from the cash provided by new investors. The scheme collapses when the initial investors want their principal back and there aren't enough subsequent investors to cover it.
  • Step 5: Question a plan that promises a much higher return on your money than you could hope to receive through the usual channels, like stocks, bonds, and certificates of deposit. If you don't fully understand the investment, don't invest until it's explained in terms you can understand.
  • TIP: Keep in mind that the possibility of high returns almost always comes with high risk, even in legitimate ventures.
  • Step 6: Be skeptical. Ever since 1920, when Charles Ponzi cheated New Englanders out of millions, prudent investors have known that anything that sounds too good to be true probably is.

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