THE notorious ponzi scheme named after Charles Ponzi was applied by him in the 1920s. At that time, this business started as a legitimate one, by focusing on arbitrage. Along the way, the business used investors’ money to make payments to earlier investors and himself.
Irrespective of how the diversion of the money goes, what is perplexing is the high “returns” that is being promised to investors. To maintain such high returns, the scheme will constantly need a steady and strong flow of money. This can only come from new investors.
While in the ponzi scheme investors are expected to enjoy regular high returns from their investment, the pyramid scheme tends to offer steady “profits” on the basis that the number of investors continues to increase. In both schemes, it is self-sustaining as long as the inflow and outflow of cash matches.
The salient difference is on the type of products and the structure offered by the ponzi and pyramid schemes.
While the ponzi scheme is based on investment management services, in which case the investors contribute money to the “portfolio manager” who promise to deliver high returns, the pyramid scheme depends on recruitment of new investors who, in turn, will continue to recruit investors for a structured product and received money.
Here, each investor pays the person who recruited them for the chance to sell the item. The recipient must share the proceeds with those at the higher levels of the pyramid structure. The pyramid scheme differs from a multi-level marketing which offers legitimate products like Amway, Melaleuca, etc.
Since both these schemes do have commonality, it is important to have a better understanding on the scheme and products irrespective if one is a first-time investor or one has been investing for many years.
Investors should be aware of some of the common questions that needs to be answered before they plan to commit their earnings into such investment.
First and foremost, investors must be aware that every investment carries some degree of risk. If an investment promises exceptionally high returns, the accompanying risk will also be extremely high. It will be advisable for investors to re-examine any investment opportunities that “guarantee” returns which are extremely high.
Next, one has to remember it is generally difficult to have an overly consistent high returns for a prolonged period of time. The reason being, driven by uncertainties on the global front, generally investment values tend to fluctuate over time, and what more if the investments tend to offer potentially high returns.
Besides, such schemes will tend to encourage investors to “roll over” investments and sometimes promise returns offering even higher returns on the amount rolled over.
Third, investors should examine to determine the ability of an investment to continue generating high regular returns irrespective of the market conditions.
In this respect, when the investment strategies becomes complex and/or secretive without complete information, investors should relook at their decision in wanting to engage in such investment by merely focusing on high returns. This should be a good rule of thumb.
Finally, they need to know when the investment scheme like the ponzi scheme are regulated or not by the relevant authorities. If it is not regulated by the relevant authorities, it should raise their eyebrows with the underlying focus being whether such scheme is reliable and able to fulfil the promises of such high returns.
Generally, these kind of investment scheme are not regulated. This will limit investors with access to key information about the company’s management, products, services and finances.
However, irrespective of the scheme, be it ponzi or pyramid, some individuals will still want to participate. Part of the reason could be due to trust, while some could have been enticed with the remarkable steady returns promised in the case of the ponzi scheme.
Hence, it can be difficult to totally put a total stop on these kind of scheme. And what more with the growing technology, more online trading schemes could emerge.
Hence, the best way out is to educate potential investors. These investors could be a first timer or have been investing for many years. What they should be looking at is for the answers of some of the basic questions before committing to an investment.
The salient answers that potential investors need to know are from these basic questions such as:
> is the seller licensed?
> is the investment registered?
> examine the risks and potential rewards?
> understand the investment?
> and importantly, is the investment regulated?
Anthony Dass is chief economist and head at AmBank Group Research