We all want a decent return on our investments but with higher returns comes higher risks. Every now and then the media reports an investment organisation collapses and many people lose their investments and its labelled a Ponzi scheme.
In this article we provide examples of Ponzi schemes, how they ultimately fail and what you can do to avoid them.
Ponzi Scheme Explained:
- Bernie Madoff: Bernie Madoff ran one of the most infamous Ponzi schemes in history, defrauding investors of approximately $65 billion. He promised high returns and consistently paid earlier investors with funds from newer investors, without actually making legitimate investments.
- Melissa Caddick: Melissa Caddick, an Australian con artist, operated a Ponzi scheme as well. She promised high returns on investments but used new investors’ money to pay earlier investors. Her scheme collapsed, leading to losses estimated to be around $23 million.
- Chartwell Geelong: A lot closer to home, in the late 2000’s Chartwell collapsed with $70 million lost by 100 investors. As with the other examples, extraordinary returns were offered. It ultimately transpired that the operators were (to a certain extent) relying on a fortune teller to help them select investments.
Why Ponzi Schemes Collapse:
Ponzi schemes inevitably collapse for several reasons:
- Insufficient Funds: As more investors join, the scheme requires an ever-increasing flow of new money to pay returns to earlier investors. When the inflow of new investors slows down or stops, the scheme can’t sustain itself.
- Lack of Legitimate Investments: Ponzi schemes don’t generate actual profits through legitimate business activities or investments. The returns paid to investors come solely from the contributions of new investors, leading to an unsustainable financial model.
- Inability to Meet Withdrawals: When a large number of investors try to withdraw their funds or profits, the scheme may struggle to fulfill these obligations, revealing its insolvency.
- Exposure or Investigation: External scrutiny, regulatory investigations, or increased attention from authorities can trigger the collapse of Ponzi schemes as the fraudulent nature becomes evident.
Protecting Yourself from Ponzi Schemes:
- Be Wary of High Returns: If an investment promises exceptionally high returns with little or no risk, it’s a red flag. Remember, “If it sounds too good to be true, it generally is.” Ponzi schemes often promise consistently high returns, which are not sustainable in legitimate investments.
- Verify Credentials and Licenses: Before investing, verify the credentials and licenses of the individual or company offering the investment opportunity. Legitimate investment advisors and firms should be registered with relevant regulatory bodies.
- Understand the Investment: Take the time to understand how the investment generates returns. Ask questions about the underlying assets, business model, and revenue streams. Ponzi schemes often lack transparency or provide vague explanations about their operations.
- Avoid Pressure and Urgency: Be cautious of investments that pressure you to make quick decisions or create a sense of urgency. Ponzi schemes often use tactics to rush investors into handing over their money without proper consideration.
- Seek Professional Advice: Always seek advice from a qualified and reputable financial advisor or accountant like Infuse Advisors & Accountants. They can help you assess the legitimacy of an investment, review its risks, and provide guidance on making informed financial decisions.
Being aware of the warning signs and seeking professional advice can significantly reduce the risk of falling prey to Ponzi schemes or fraudulent investments. Understanding how these schemes collapse can also help investors identify potential scams.
There’s an old latin term ‘caveat emptor’ which translates to ‘buyer beware’. With regard to investments, it can be reframed as ‘investor beware’. If in doubt, always see professional advice. If you’re offered an opportunity to invest that sounds a little too good, please contact us at Infuse for guidance and referral on to other professionals (if appropriate).
