Forensics

·

30 Sep 2014

How to Avoid losing to a Ponzi Scheme

READ TIME

3 min

The wolf in the sheep’s clothing

Ponzi schemes by their very nature are disguised in various ways to avoid identification. A well-designed Ponzi scheme is the epitome of the wolf in sheep’s clothing. The infamous Bernie Madoff, who took investors for an estimated $65 billion, scammed people including the rich and famous, banks and even charities. In fact, with a small team of co-conspirators Madoff established a global network of investors from more than 40 countries, 339 funds of funds (where funds invest in other funds), and 59 asset management companies.

Nobody is fully immune to a skilled conspirator such as Madoff, and many Ponzi schemes are designed to rely on people with the kind of ego that demands that they will be able to detect a scam. And beyond the ability to convince the most experienced and financially literate people, is the element to entice them in.

To help avoid this type of investment scam, follow these tips:



  • Avoid Unsolicited Investment Opportunities: Reputable investments generally are not promoted by telemarketers, email or flyers. If you are approached and presented with an investment opportunity through these marketing channels the possibility of a scam is increased and should be considered a red flag.

  • Urgency: Don’t be pressured into making quick decisions. If high pressure sales tactics are involved, take a step back and review the investment objectively on the merits.

  • Unrealistic Returns: If the investment offers unrealistic returns it is essential to find out why and how the investment is able to achieve such returns. This applies to both higher than normal returns or consistent returns. We all know that the market fluctuates and economic conditions play a role in the returns achievable. We also know that generally the higher the risk the higher the return. So, when investments are promoted as low risk with high returns this is a significant red flag. Another red flag is consistent average returns, as with the Madoff hedge fund despite what transpired in the market and economic conditions the Madoff fund produce stable returns of approximately 12%, consistently every year. A review of Madoff’s historical returns shows it is not statistically possible to regularly produce 12% returns and therefore certainly not possible in reality.

  • Due Diligence: Often there are warning signs in the information provided by promoters of the Ponzi scheme that if properly scrutinised would raise red flags. Be sure to research and consult with a trusted advisor. A brief consultation with an independent accountant or lawyer could save you from investing in a scam.

Ponzi schemes are often sophisticated and while hindsight makes the red flags clear to see they are not always obvious at the time. Given that there will always be scammers, one way to avoid losing your entire investment portfolio is to diversify, or simply put—don’t invest all of your money in one place. So many people, who fall victim to frauds such as the Trio Capital fraud, lose everything because they have their entire portfolio invested.

From a fraud prevention perspective, as opposed to a financial investment strategy, there is a sound argument that no one investment should comprise more than 25% of a portfolio. By structuring a portfolio this way, if one investment turned out to be a Ponzi scheme or another type of fraud it would be possible to get out without losing the entire portfolio.

Always remember, if it looks too good to be true it usually is!

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