What is a Ponzi Scheme?

In the early 1920’s, Charles Ponzi, an Italian immigrant, tricked thousands of New Englanders into investing in a firm that was not legitimate. By taking advantage of all of his clients, he initially scammed an estimated seven million dollars out of his investors before he was caught. He was imprisoned for 86 counts of mail fraud, and he spent 17 years in prison. So what is a Ponzi scheme, you ask.

What it is

Imagine taking all of your hard earned money and investing into something that was promised to generate quadruple what you put into it in just a month or two. Well, that is exactly what this scheme convinces investors to do. This scheme focuses firstly on the new members. Once there is a small clientele base, the scammers seek out higher investors, and they continue to do so in tiers. Now, the catch is that there is not actually a business to invest in. The first set of investors filled the scammers’ pockets. The second set of investors paid the first set of investors a small portion of their money, and the rest of the money went into the scammers’ pockets. That pattern continues as long as there are people willing to invest.

How it all Falls Apart

The scheme typically begins to topple due to either a lack of new investors or a large number of investors asking to cash out their investments. If there are no more people willing to invest, the scammers have nothing to hand down to the lower tier investors, and eventually the clients catch on to the scam. If a large number of people begin to cash out their investments, there are typically not enough funds to satisfy everyone, so the scam begins to crumble. In the end, the scheme will fall apart.

How to Avoid the Scheme

According to SEC.gov, there are several red flags to be aware of when making any investment, but the most important is to pay attention to the risk and the reward. Any high risk investment will have larger rewards amounts, but low risk investments seldom do. If someone guarantees you little to no risk along with a set amount of money that will be made from the investment, chances are that you have found yourself a scammer. Be wary of consistency, as investing is anything but consistent. All investments go up and down. If you are constantly getting paid the same amount, there is something not right about that investment. Get out of it as quickly and quietly as possible while contacting government officials about the possibility of a Ponzi Scheme.

A Ponzi scheme does not only hurt the client, but it hurts investors everywhere. Due to the nature of the scam, there are many schemers who are never caught because they give fake information about themselves and try not to leave a paper trail. Nowadays, these schemes are not as prevalent, but there are still people out there who try to scam hard earned money from innocent people. While that use of the Ponzi scheme has dwindled down, there are still thousands of new scams surfacing every day.