Whether you are an investor looking for a fast and easy way to generate a substantial return or a job seeker searching for a fabulous money-making opportunity, you may want to keep your eyes open for potential Ponzi schemes. If you are asking yourself what is a Ponzi scheme, it is important to learn more about Ponzi schemes so that you can avoid them whenever possible.
Understanding Ponzi Schemes
If you are wondering what is a Ponzi scheme, you should be aware that this is a type of fraudulent activity that promises to generate fabulous returns for investors with little or no risk. However, with a Ponzi scheme, the returns are not based on anything substantial or real.
The result is that the investor stands to lose a considerable amount of money over time. In some cases, this may be a short period of time. In many cases, however, the investment period is long.
The term Ponzi scheme originated in the 1920s when a scam artist named Charles Ponzi attempted to steal a large sum of money from New England residents in a postage stamp scheme. He promised to generate a 50 percent return on investment to these individuals within a 90-day period.
In order to keep up with his deceitful plan, he started to bring on even more investors to pay off the initial investors. As is the case with any Ponzi scheme, this methodology soon imploded, and the structure collapsed.
Now that you know more about what is a Ponzi scheme, you may be wondering what some of the warning signs to watch out for are. Generally, you may be a target of a Ponzi scheme if someone is offering you a deal that sounds too good to be true. A high rate of return and minimal risk are general characteristics of these schemes.
It may require you to make a substantial investment, but the deal may not be registered with the SEC. You may have trouble confirming the accuracy or legitimacy of the offer, and you may also have trouble cashing out on your investment as desired.
Advantages of Disadvantages of a Ponzi Scheme
When you ask what is a Ponzi scheme, it is important to note that there are many disadvantages associated with this type of opportunity, and there are only a few advantages. With a closer look at the advantages and disadvantages of a Ponzi scheme, you can make a more educated decision about how to proceed with your funds.
Advantages of a Ponzi Scheme
As crazy as it may sound, a Ponzi scheme does offer some advantages, either to initial investors or to a possible victim.
1. Initial investors will get a return on their investment
The very nature of a Ponzi scheme involves the funds of later investors being used to pay off the initial investors. This means that the scheme actually will produce a great return for the first investors that come in the scheme. In the event you happen to be one of these investors, you may reap a sizable return.
Usually, the scam artist responsible for devising the plan also gets a great return. However, this individual also faces the very real possibility of going to jail when law enforcement officials learn about the Ponzi scheme.
2. Despite what you think, it is easy to spot
Some people believe that Ponzi schemes are elaborate and complex, and because of this, they believe that they are difficult to spot. However, in reality, most of these schemes are rather basic or simplistic. Each new group of investors pays for the return on the previous group of investors’ investments. This means that each new group needs to be larger than the previous group.
If you want to discover if an investment opportunity is a Ponzi scheme, you should avoid listening to the amazing words of initial investors. Instead, you should think through the probability or likelihood that the opportunity can remain present indefinitely. Essentially, ask yourself what is generating the profit or return and if it is legitimate and sustainable.
Bonus read – What Is Price/Earnings Ratio?
Disadvantages of a Ponzi Scheme
As you learn more about what is a Ponzi scheme, you can easily see that there are many disadvantages associated with this type of opportunity.
1. Ponzi schemes are punishable by law
A Ponzi scheme is a type of fraudulent activity. Law enforcement officials may prosecute those who actively solicit funds from investors under this type of scheme.
2. Investments in the scheme are lost
The investors themselves often lose a substantial amount of money. A Ponzi scheme inevitably will collapse on itself and when it does, investors will lose their funds.
3. Initial investors might rejoin the scheme
The initial investors who may profit from the scheme at first likely will re-invest in the scheme. They will do this at a later date to further increase their profits. This means that even the initial investors stand to lose a small fortune when the plan ultimately implodes.
Example of a Recent Ponzi Scheme
The Bernard Madoff scheme is perhaps the most notable recent Ponzi scheme in the U.S. This scheme imploded in 2008. At this time, the economy was collapsing. Many investors tried to pull their funds out of investment accounts they had opened with Madoff’s investment company. With so many people attempting to pull funds out at the same time, the scheme came apart. Billions of dollars of investors’ funds were lost as a result.
It can be difficult to determine if an investment opportunity is legitimate or not. After all, Madoff was once a Chairman of the NASDAQ board of directors. He had also been well-known in the investment industry since the 1960s. Investors who gave his firm their money had every reason to believe that he could produce a great profit legitimately.
Conclusion
As you can see, it is not always easy to determine what is a Ponzi scheme. Investors should always be aware of this possibility and should thoroughly review and vet their opportunities before moving forward. While nobody wants to miss out on a great investment opportunity, it is important to note that risk and reward often go hand in hand. If an opportunity seems to produce an incredible return with minimal risk, it likely is not legitimate.
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