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The Truth about Ponzi Schemes - Views on News from Equitymaster

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The Truth about Ponzi Schemes
Apr 22, 2016

When I was doing my post-graduation in Pune, many of my friends were busy filling online survey reports. I was curious and asked why. One of them told me he gets Rs 4,000 per month for one year by investing just Rs 11,000. 'Can you get those types of returns in the stock market? I don't think so,' he added.

I was surprised. I wondered about the company's business model and whether it was generating enough revenue to disburse the monthly payments to its subscribers. I wondered if it was sustainable...if it wasn't just another Ponzi scheme. Well...I am referring to Speak Asia, and yes, it was a Ponzi scheme.

Suppose someone told you they can double or triple your money in six months. What would you say? Probably something like 'this is not possible', 'this is a fraud', 'I will lose my money', 'I don't trust this person', etc.

But here the trick...

If the company creates a product or service (i.e. an online survey), advertises (to create brand awareness), and incorporates a business model through which it collects money in advance and distributes it on a monthly basis after the completion of work (i.e. after filling an online survey), it creates a different situation. Let's consider how most people will respond to this...

  • Ooh...here I have to fill an online survey...and then will I get the money. (Creates the illusion of working for the money.)
  • This company has a business model where you have to fill online surveys to get paid. (They never go deep enough to understand how the company will get paid and by whom.)
  • Even if I fill the online surveys for three months, I will recover all the money I put in. (Loss minimisation strategy and a worst case scenario.)

How does this happen?

Well, the early birds make money on their investment. This builds trust and confidence. Through multi-level chains, early birds start marketing on the company's behalf with the proof that they made money on their investments. Positive word of mouth can get even a rational thinker to buy a product or service. If a person you trust makes money on some scheme, you'll probably want in. You may even tell your friends to invest. This chain then goes on until one fine day, news comes that the company is a fraud and investors have lost their money.

How to avoid a Ponzi scheme

Be skeptical and ask lots of questions. The more questions you ask, the better the picture you will get and the harder it will be for anyone to 'pull the wool over your eyes'. Here are some good questions to ask:

  • What does the company do? How does it make money?
  • Where is the investment regulated and licensed?
  • Are the returns realistic? What are the risks?
  • Where does the money come from to pay the investors?
  • Why is somebody trying to sell this investment to me? What is in it for them?
  • Are their financial claims independently audited? Is their performance record realistic?

Beware of vague and unsupported statements, both about the financial performance of the business and the actual investment strategy. Many Ponzi crooks claim their technique is secret, confidential, or too complex for outsiders to understand.

Bottom line - don't invest if you don't understand. And if it's too good to be true, you should already know what to do...

Sarvajeet Bodas

Sarvajeet Bodas (Research Analyst), holds a master's degree in finance. He has been a finance blogger for more than four years, covering various topics in personal finance and investing. His deep interest in behavioral finance was inspired by Charlie Munger, Howard Marks, Guy Spier, and the works of Daniel Kahneman and Richard Thaler. He likes to study the business models of companies in detail, keeping in mind the big picture and focusing on current risks and challenges.

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1 Responses to "The Truth about Ponzi Schemes"

Savio

Apr 25, 2016

This is very similar to QuestNet (earlier GoldQuest) that is also like a Ponzi scheme. They created "products" that people could buy so as to make them believe that it wasn't a ponzi scheme.

I lost at least three friends (in Pune) when I told them that this was a ponzi scheme and that there was no real business model other than deceit.

To fool gullible customers, they liberally quoted from Rich Dad Poor Dad and other famous books. :)

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