Is it a ponzi?

Peter posted this on September 28, 2020

Just some days ago a good friend introduced an investment scheme to me where I’m supposed to put in my capital and get 20% paid to me every month and then my capital back at the end of 6 months.
Immediately the opportunity was described to me I at once knew there was something off and fishy.

In March 2009, US stock broker and former non-executive chairman of the NASDAQ stock exchange, Bernie Madoff  was sentenced to life in prison after being found guilty of operating the largest ponzi scheme recorded in the history of the world with $65 billion in losses!

He claimed to be consistently profitable trading stocks for clients but would just take money from new clients and pay that out as “profits” to older clients .
The fraud was unravelled when he ran out of cash to pay (possibly as a result of the 2008 financial crisis) and confessed to family members who reported to the authorities as a Ponzi scheme can last only as long as new money is flowing in to pay existing investors.

A Ponzi scheme is a form of fraud that lures investors in with promises of high, consistent profits and pays profits to earlier investors with funds from more recent investors.
The scheme leads victims to believe that profits are coming from product sales, trading or other means, and they remain unaware that other investors are the source of funds.

A Ponzi scheme can maintain the illusion of a sustainable business as long as new investors contribute new funds, and as long as most of the older investors do not demand full repayment and still believe in the non-existent assets they are purported to own.

Please note that this is different from a pyramid scheme which relies on promising  “investors” rewards for recruiting more people (which usually fail when people stop joining).

Fortunately for me I have never invested in a Ponzi or lost money to one but it’s unfortunate seeing a lot of people get deceived by the promises they make which is why I’m making this post.

I have so much to say on this topic but would keep it short and to the point so I would just go straight to some signs that a scheme is a ponzi.

– Unusually high returns with almost zero risk

Conventional wisdom is that with higher risks come higher returns vice versa.

This can be seen when you invest in Government bonds (of an economically sound, low risk country) and receive really low but stable yields as a result and can also be seen when you buy a lottery ticket and might win (out of a million other people).

Ponzi schemes would usually turn this on its head and offer market beating high returns with very low attendant risk.

-Complicated and usually hard to understand investment methods

This is usually the first sign that an investment scheme is a ponzi.

When you invest in a quoted company on the stock exchange, you are putting money into a company with the hope that whenever it makes a profit, you would get a share of that.

When you invest in government bonds, you are loaning your money to the government for a fixed term with an agreed amount of interest and your capital back after a period of time.

A ponzi would for the sake of obfuscation usually attribute their high returns to some vague process or strategy (split-strike conversion in the case of Madoff) which can’t be understood regardless of the effort.

I don’t put my money into what I can’t understand & I don’t think anyone else should too.

– Returns are too consistent.

Progress in life never happens in a straight line. Profits from business/investments almost never do either.

This is because everyday we are faced with unknowns and unpredictable occurrences (Covid was for 2020) which can alter our path and mince our projections.

With a Ponzi though, growth takes a straight, sane and predictable curve. Let’s take a Ponzi claiming to trade Bitcoin or any other financial instrument for instance.

Above is Bitcoin price history from 2009 to 2019. We can see it can go really high and really low (it’s over $20,000 at the moment) but a ponzi would advertise an investment and offer consistently returns every single month (never accounting for the dips).

– Unusually high returns with almost zero risk

I’m reading of a “forex trader” who offered clients 40% return on their capital PER WEEK! Meaning I’d double my money in less than a month if I put it there and get maybe 21x my initial Investment at the end of the year.

If that’s how things worked I’d sell my business, but every pence in there and live the rest of my life on the interest but unfortunately, that’s not how they work in real life.

I’d usually get about 9% PER YEAR investing in Government bonds, 1 -5% on savings deposits and maybe 20% PER YEAR averagely on stock investments and these are universally obtainable.

While nothing is impossible, 40% (or even 5%) a week consistently long term is a stretch.

– Not recognized by relevant authorities

Financial services firms and financial markets are usually vetted and registered by different bodies depending on location such as the Financial Conduct Authority. It is common for those operating ponzis to hide under the guise of being new or unique to explain why they aren’t registered by financial  regulatory bodies.

While some are smart and are actually registered and have the shroud of legitimacy (remember Madoff?), most can provide nothing when you ask for proof of vetting by relevant bodies as these bodies would simply not register them.

– Getting paid your capital can be complicated

In a ponzi, your capital is your (& a few people else’s ) interest.

In a typical ponzi, it would usually be really difficult for you to get your capital back when you want it because the survival of the scheme depends on money being available in bulk to pay “interests”.

This is why most ponzi’s usually fail at points when a lot of people need cash at the same time such as recessions or at year end for holidays.

– Reluctance to issue paperwork

I talked of an “investment” a friend mentioned at the start of this article. I asked to see a document outlining the agreement between the company and client, terms, methods of arbitration as well as any other paperwork relevant to the investment.

There was none.

Most people who start ponzi schemes (not all, a lot start with good intentions) start them with a plan to vanish on meeting a specific financial target.

Issuing a lot of paperwork would make them more traceable at the point when they close shop and give clients a ground to sue them.

– Feels too good to be true

The final point, if an offer feels too good to be true, it usually is!

A lot of people are fortunate to invest in and get out of ponzi’s with profits before they unravel so ultimately, how you spend or invest your money is a personal decision.

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