How to Avoid Ponzi Schemes
Posted February 2, 2009 by Bernz
The recent arrest of celebrity financier Bernard Madoff brought to light an old investment scam, one that is enjoying a recent resurgence as investors try desperately to hold on to their returns.
The ponzi scheme is named after 1920’s investment manager Charles Ponzi. Ponzi had promised his investors that they would double their money in 90 days- a feat which was not being accomplished anywhere else at the time. Dubious investors were won over by testimonials by happy clients and were soon bringing in amazing returns on their own investments. What Ponzi didn’t tell anyone was that it was impossible to make that kind of return on investment. What he had to do to keep up appearances was to pay the astronomical returns out of new investment contributions. Ponzi’s scheming would have eventually collapsed when the new money couldn’t keep up with the promised returns but instead Ponzi called himself out. He was irritated that a firm down the street had started a similar program and he called the police. Ponzi spent several years in jail before being deported back to Italy. He died penniless two decades later.
Bernard Madoff invested the funds of celebrities, charities and wealthy individuals. People clamored to give their money to him as he was delivering stellar returns with supposedly little risk. When the market started its slide south, Madoff couldn’t juggle all the balls in the air and his ponzi scheme was discovered. He awaits trial.
How can you make sure that you don’t fall prey to a similar scheme? It’s actually easier than you think. Never put all your money with one investment manager. Remember the old saying about the eggs and the basket. Spreading your investments out lessens your risk. Understand the investment statements you receive monthly or quarterly. Your investment statements should clearly outline the individual investments in your portfolio. If you are getting only lump-sum numbers, it’s time to ask questions and do some digging. And most importantly, find out what a reasonable return on a similar investment would be. For example, if bonds are returning an average of 3.5% and your investment manager is telling you that you can get 8% in his bond fund, there is likely something wrong. Increased returns mean increased risk to you, the investor. In the end, common sense will help keep you away from unscrupulous ponzi schemes.
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