Ponzi scheme scams and pyramid schemes are one of the oldest types of scams. They are basically “get-rich-quick” schemes that make big promises in return for your initial investment. The prospect of quickly growing your assets is often just too tempting, and many people ignore the red flags. Read on to better understand Ponzi and pyramid schemes and how to spot them
Ponzi Schemes and Pyramid Schemes: How Do They Work and What’s the Difference?
Ponzi schemes are usually investment opportunities that build hype and confidence by paying the initial investors with the money collected from new investors. When the scammers meet their financial goals, the business suddenly folds without warning, and you end up losing everything. A Ponzi scheme is not the same as a legitimate business that unexpectedly folds; that’s just a bad investment. Instead, it is a “scheme” because the scammers deliberately lie about where the income is coming from, with the specific plan of recycling and then taking investor funds.
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Despite being a well-known trope, explored in movies like “The Wizard of Lies” (2017) in which Robert De Niro plays Bernie Madoff, Ponzi schemes are still surprisingly common.
The terms Ponzi scheme and pyramid scheme are often used interchangeably, but they are not exactly the same. Ponzi schemes are usually “centrally managed,” with one conman or team of conmen at the center of the action, recruiting victims. Pyramid schemes recruit an initial round of participants and then tell them that they can make money by recruiting further participants, in a sense, “outsourcing” the recruitment aspect of their fraud. Through investment, subscription fees, or product purchases, money flows up the pyramid, with those at the top earning big returns, and those at the bottom losing out when the unsustainable business model inevitably collapses.
Examples of a modern pyramid scheme are Vemma Nutrition, which was shut down by the FTC in 2015, and Herbalife, which was forced to settle a class-action suit with 8,700 former and current distributors in 2004 and pay $200 million in an FTC settlement in 2016.
How to Spot a Pyramid Scheme or Ponzi Scheme
There are a few telltale signs that should indicate that an investment opportunity is too good to be true.
High Return on Investment (>10%)
When it comes to investments, a return of between 7%-10% annually is considered good. Diversified stock market investments, such as the S&P 500, historically average around 10% per year. If you are being pitched more than 10%, especially over a short period, this should be a red flag for a Ponzi scheme.
Guaranteed Return on Investment
Investing is always a gamble, as you just don’t know what the market is going to do. No one can guarantee with certainty that you won’t lose your investment. This is true for Ponzi schemes and pyramid schemes, which cannot guarantee the level of sales or recruitment you need to make a profit.
The Investment Is Long-Term or Unended
If you are being asked to make a long-term investment, and you are being guaranteed consistent high returns, this can be a warning sign for a Ponzi scheme. It means that the promises being made do not account for inevitable market fluctuations.
Lack of Transparency
If the scheme is reluctant to share verifiable details about its business and activities with you, it could be because those details do not exist as described. Ponzi and pyramid schemes often hide the details of their business to mask the fact that their models are fraudulent or unsustainable.
You Are Strongly Encouraged to Reinvest Your Dividends
Ponzi schemes will often encourage you to reinvest your dividends. This means that they have you as a happy investor, thinking that you are making big returns on your investment. But those returns do not exist, or the scammers have no intention of paying them out. Similarly, if you initially make money in a pyramid scheme, you are often encouraged to invest more for a bigger return on investment, but the promised business growth is unsustainable.
You Are Encouraged to Recruit Other Investors
Ponzi schemes, but especially pyramid schemes, are all about growing their number of investors, so they will often encourage you to recruit others on their behalf, sharing your positive experience. This is also why it's a red flag if a recruiter or a friend tells you that they have invested in the scheme and talks about the great returns they've had.
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When my sweet old grandmother got caught up in an Amazon gift card scam, I decided then and there that I needed to do whatever I could to inform as many people as possible about the grifters of the world. That’s what I do here – writing about modern scams so you don’t get caught out.
Great videos on scams!! Thanks.
My wife and I are Senior Citizens. We get garbage emails all the time. I have a few questions.
If we use “alias” email addresses, do they really assist in reducing the number of scammers? (We are new to this type of email).
Are there any “Real” opportunities to make money online or is everything fake?
Have you done a video about Senior Citizens being targeted by scammers?