Former India cricketer and U-19 team coach Rahul Dravid and badminton Olympian Saina Nehwal were among the celebrities who had parked their funds in a Bengaluru investment firm accused of cheating at least 1,776 investors to the tune of over Rs. 300 crores. The firm lured high-net worth investors with offers of 40 to 50 per cent annual returns on their principal amounts. Police investigations say that the firm paid the celebrities the promised returns in the past but defaulted on payments to others. Names of the celebrities were used to lure unsuspecting investors.
How Ponzi Schemes Work
In a classic Ponzi scheme, a high rate of return is offered to lure people and the new money is used to pay off old investors who want to redeem their investment. This keeps running so long as the money coming into the scheme is greater than the money leaving. When this equation is on the verge of reversal, or often much before that, the person behind the scheme takes the corpus and disappears. The largest Ponzi schemes are essentially word of mouth. Typically, someone around you has invested in a scheme. The scamster is interested in reaching a certain level of scale. Initial guys tend to get paid off. Then they go talking about it and become votaries for that scheme.
Commonalities across Ponzi Schemes: Red Flags
Promise of extremely high returns
Anyone with an understanding of finance knows that no one can promise a 40 per cent annual return. The greatest investor in the world is Warren Buffett and the returns he made over his lifetime are around 20 per cent annually. However, Ponzi schemes tend to focus mostly on the returns and try to hide or brush aside the risks. This is one of the key things that leads many investors to fall for a Ponzi scheme. The lure of high returns simply blinds all logic.
Pay initial returns really fast
Initially, these schemes find a way of making the returns available to you really fast. This convinces people about the scam’s genuineness and they start talking about it. The next instant, you have family, neighbours and everyone participating. They are taking the next person’s money and giving it to the first. Then there are 10 more whose money is passed on.
Life lessons learnt
1. Never blindly trust reputation
Many investors got lured into this scheme because they saw celebrity names as fellow investors. They blindly trusted the investment decisions made by celebrities without proper due diligence. If you are suspicious something is amiss, don’t be put off from taking a look because the entity or person is too revered, or you think it is too big to be based on fraud. Don’t assume due diligence just because of reputation.
2. If It’s Too Good to Be True it Probably Is
Ponzi schemes typically deliver high returns in their initial years. This is done to gain investor confidence and attract new people. Investors pool in more money with the belief that such high returns will continue in future. Be suspicious of stellar results all the time. Everyone and every company has a bad day at some point.
3. Be suspicious of secrecy
Fraudsters try to hide important information about their investment strategy and business model. Claims of hiding information for “competitive reasons” could be to conceal that what is really going on isn’t exactly legal.
4. Don’t Fall for False Complexity
Frauds are perpetuated by claiming that what they were doing was very complicated and couldn’t easily be understood. If someone tries to put you off by saying that it’s too complex, ask them to explain it to you and don’t stop until you have a full understanding. Avoiding investment schemes that you do not understand is the simplest way to avoid getting conned.
Conclusion : Don’t fall for fantasy
The main point to bear in mind is that a Ponzi scheme might look obvious only in hindsight and things are easier said than done. It takes a lot more effort especially, if you are introduced to a Ponzi scheme by a family member, relative or a friend, someone who is close to you and someone you trust fairly well. The best way to protect oneself against a Ponzi scheme or any investment idea or a strategy is to ask questions and spend time on the details.
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