The news has been full of stories about Ponzi schemes in recent years, in relation to big banking and investment scandals. This is a type of scam investment that is named after Charles Ponzi, who was known for constructing a large scheme designed to dupe investors in the early 20th century. A Ponzi scheme has the ultimate goal of trying to convince individual investors to put their money and interest into a fraudulent investment, before the scam artist then disappears. This involves several steps which are designed to instill confidence in investors, to convince them to part with their money and then never see any profit.
Ponzi schemes begin with a promise that the investment at hand will give them a high rate of return. This is always marked out to be a rate of return which is above normal, to create the feeling that the investment opportunity is one not to be missed out on. It has to strike a balance between being high enough to seem like a worthwhile investment, but not so high that it is unbelievable. Once the payoff or benefit has been set up, the investor will then receive some sort of explanation of how the payoff will be achieved, and why the investment is so special. This usually relates to insider information being traded.
After the person or company running the scheme has convinced a few individual investors to put their money in this investment, they then need to make payments at the promised rate of return. This is an important step in Ponzi schemes because it builds credibility and helps convince other potential investors to step up to the plate as well. This cycle is repeated a couple of times, so that there is a track record of several positive rates of return.
Finally, at some point in the cycle when more investors have invested in the scheme, the scam artist will pull the money and typically disappear without a trace. Although Ponzi schemes can be quite simple, they have a track record of success. The latest story that was all over the news is the Ponzi scheme set up by Bernard L. Madoff Securities LLC, which ended in a net loss to investors of nearly 50 billion dollars. Care is always necessary on the part of investors to avoid a Ponzi scheme, which is why research and credibility are so important in the world of investments.