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What is a Ponzi Scheme?

With the recent death of Bernie Madoff, you may be asking yourself what is a Ponzi scheme and how can you make sure it doesn't happen to you?

A Ponzi scheme is a fraudulent investing scam that generates returns for earlier investors with money taken from later investors. The whole premise works on continuing to get new investors to pay back early backers.

Ponzi schemes are usually targeted to average investors looking for a quick and fast return on their money. The Bernie Madoff incident was unusual because he targeted high income people who should have had more sophisticated investment knowledge. In the end, Mr. Madoff defrauded investors of nearly $65 billion from 4,800 clients.

How can you protect yourself from fraudulent investors? Here are some tips:

1. Be Skeptical

If someone tries to sell you on an investment that has huge and/or immediate returns for little or no risk, it could well involve some sort of fraud. For example, Bernie Madoff provided investors with consistent return of 1-1.5% per month for 10 years before everything fell apart.

2. Be Suspicious of Unsolicited Offers

Someone contacting you unexpectedly, perhaps inviting you to an investment seminar, is often a red flag. Investment scams often target elderly people, or those close to or in retirement.

3. Check Out the Seller

Research a broker, financial advisor, brokerage company and investment advisor firm before you hand over your money.

4. Verify the Investment Is Registered

Ponzi schemes often involve unregistered investments, says the Securities and Exchange Commission (SEC). Start by asking the person offering the investment if the investment is registered. If not, ask why.

5. Understand That Investment

Never put money into an investment you don’t fully understand. There are many online resources to help you learn how to invest and how to evaluate opportunities for risk and potential gain. Don't write a check to – or open an account with – anyone who won’t fully answer your questions or who tries to discourage questions by saying the investment is using secret, proprietary or too-complex-for-laymen strategies.

The Bottom Line

It’s vital that you know who you are dealing with and that you understand any investment before handing over your money. Be doubly careful if someone contacts you unsolicited about an investment. If anything seems off to you, report it to the authorities and let them figure it whether it’s legitimate or not. As the adage says, "If it sounds too good to be true, it probably is."

*Information referenced from: Investopedia. Crime and Fraud. June 25, 2019. Anthony Giorgianni.


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