What is a Ponzi Scheme?
A Ponzi scheme is an investment fraud or scam where money from new investors is used to pay returns to earlier investors. It is a form of pyramid selling and works on the premise that the earlier investors will attract others to invest, so the fraudster can keep the scheme going.
The fraudster promises high returns with very little risk. Investors are enticed to invest money in what turns out to be nothing more than a chain letter type of arrangement, with a little trickle of payment for early participants and a deluge of payments to the con artist responsible for the scheme.
The scheme is named after Charles Ponzi, who gained notoriety in the 1920s for such activities. While Ponzi Schemes have been around since the 19th century, they are still prevalent today, particularly in the form of internet-based scams.
How a Ponzi Scheme Works
In a Ponzi scheme, the fraudster encourages investors to ‘invest’ in their scheme, promising high returns with minimal risk. However, the returns paid to the investors do not come from any profits generated by the scheme, but from the investments of other new investors. This results in a chain reaction of people investing in the scheme, hoping to make a return on their money.
The fraudster will continue to accept investment until there are not enough new investors to pay the returns on the earlier investments. This means that investors can end up losing a lot of money if the scheme is eventually uncovered and collapses.
Spotting a Ponzi Scheme
Unfortunately, the signs of a Ponzi scheme are not always obvious to spot. Here are a few common warning signs to look out for if you are considering investing in a scheme:
• High returns with little or no risk – fraudsters often promise returns that are too good to be true.
• Pyramid-like structure – any scheme with a structure that focuses on recruiting other investors is likely to be a Ponzi scheme.
• Secretive investment plan – if the scheme’s investment plan is cloaked in secrecy, it is likely to be a scam.
• Unsolicited email – if you receive an unsolicited email offering you an ‘amazing’ investment opportunity, it is probably a scam.
• Pressure to invest quickly – fraudsters will often pressure potential investors to invest quickly before they miss out on a ‘fantastic’ opportunity.
The Bottom Line
Ponzi schemes are a type of fraud that involves convincing unwitting people to invest in a product or service based on unrealistic promises of high returns with little risk. It is important to be alert and look out for the warning signs when considering an investment opportunity and if something seems too good to be true, it probably is!