With brazen criminals, licenses and certificates don’t matter. Con artists who run questionable operations can sneakily bypass regulation, and no one can put them out entirely — not now, not ever. Plenty of people are victimized and their hard-earned money embezzled.
How can anyone avoid investment scams when crooks are getting more and more crafty? Well, scams are truly deplorable, but there are ways you can take to protect yourself from them. This article suggests those measures; it also includes a practical look at a classic investment scheme and typical tactics that con men employ.
1. The first question to ask: How do they make money?
You probably wonder why you should care about what goes on behind the scenes of an investment offer. What matters to you is the money you’ll make and how the company generates its revenue is none of your concern, right?
If you can’t explain concisely about how an investment works, then it’s probably a sign that you’re involved in something shady. Also, if the people you’re dealing with don’t bother to go into the details about how they plan to return your money only strengthens the assumption that what they operate is a scam.
But I made money and so did my friends, what could go wrong?
Yes, it’s hard to argue with something that has proven to make money even if it’s a fraction of the money you risked. And, to you, it might seem like a good enough proof that an opportunity is legit and provides respite after days of misdoubt.
A quick look at the Ponzi Scheme
Charles Ponzi, the originator of the Ponzi scheme, paid investors with the money collected from new investors. If you ask what is wrong with that, then you need to take up a math class in grade school. The reason why is it’s unsustainable.
The calculation below is a Ponzi scheme applied to only ten investors to make the math simpler. Although this is not the same as Charles Ponzi’s original 50% interest after 45 days promise, this still captures the scheme’s infeasibility.
As you can see, by the end of the first year alone, the company that collected the investments of $10,000 for each investor would have $0 in cash and $98,000 in debt due to interest payments. And, just by the 8th month, the company’s balance is -$4000, and if it weren’t for Investor 9’s $10,000 contribution, they’d be $42,000 in debt at the start of the 9th month.
This scheme, however, happens on a larger scale, which means that the first-line suckers are the promulgators of good tidings because, throughout the investment’s life, they will most likely be shielded from the harrowing reality. The actual victims are the ones who come in late because sooner rather than later, the company will run out of investors, and the newcomers may not even see a single interest payment land on their hands.
The dangers of not knowing how
Not having a clue about how your investment works could make you Investor 9 or 10 in the table above. Investor 8 might be jumping for joy because the capital has been recovered plus a 20% return, but you, on the other hand, may end up with a loss.
And, if you do know that a faulty system is going on, be concerned about the others jumping on the bandwagon late because what if it was you in their place?
2. Next, ask about the return
The high rate of return is another reason why the Ponzi scheme’s viability is beyond the realm of possibility. A 30% interest per month is just ludicrous and is no way mathematically possible — unless they have troves in the black market.
If the people behind an investment say that they can double your money in the stock market in a few months to a year, walk away. Yes, stock trading and investing are all about gaining alpha but be grounded about your return expectations. The average annual return of the S&P 500 is about 8%, and although some stocks may appreciate greater than others, it does not come without its equivalent risk.
Bonds post a return of 5-6% per year; keeping money in a bank would produce 1-2%. The only way to see a 30% return per month — legally — is if you take on highly leveraged financial products and trade supernaturally well. And, if there’s a living person who can do that, then your investment isn’t something he seeks: why look for other people’s money when you can turn your $10,000 to $232,980 in twelve months?
So, anyone guaranteeing an improbable return should be scrutinized; their business, their investment strategy, or whatever they’re doing should be exposed so that the interested public knows how they generate income and returns for investors.
3. Ask about the risk
Being blinded by high returns is a pretty common ailment. Plenty of financially illiterate investors consider only the potential reward and completely disregard the existence of risk. And, scam artists know this very well, and, in fact, they exploit it.
Swindlers know that when they get their prey so drunk from wealth expectations, they’re nearly at the finish line. After employing all other deceptive tactics such us making you think that everyone else is involved and you’re the only one missing out, they know that the only thing that’s left is for you to hand over your money — which is usually automatic at that point.
Knowing the tradeoff between risk and reward is perhaps a remedy to this. The question that you should assert all the time when you’re offered an eyebrow-raising opportunity is, “what or how much do I risk losing?”
Usually, scam-artists don’t even talk about risk because they don’t want to inject any inkling into their attempt to dazzle you. They want you to focus on what you stand to win because your actual risk is all your capital the minute they consummate the deal.
No reward in the world comes without risk.
4. Spot the classic “make money fast” appeal
General rule: Any promise that says you can make money quickly with relative ease is almost always a scam. Look around the internet, and you will see a lot of it, especially those coming from fraudulent forex, binary options, and cryptocurrency brokers.
Advertisements that say “you can make thousands of dollars in a few days” or “it’s as simple as clicking buy and sell and within minutes, you earn profits” has the word scam written all over it. And, even for scams outside the financial markets, the appeal of making money fast may be evident.
Ponzi schemes and pyramiding scams, as examples, are tarred with the same brush — both are unsustainable in the long run. But recruiters in a pyramid scheme do have a distinct tactic: instead of just hyping up the potential gain, they draw out your emotions too with motivational tropes.
5. Pressure selling?
Lastly, you should be aware of pressure selling tactics, and there’s a lot of it. A common one, as mentioned earlier, is everyone’s fear of being left out and swindlers will make it seem like everyone you know, from your dog to Jason at the barbershop, made money except you.
And, another one is the scarcity tactic: scammers buff up the value of their offer by making it look like its supply or time to partake is limited.
The thing you have to do is to be wary of all the tactics. Study them. And, if you feel the slightest bit of pressure into rushing into a decision, restrain yourself and take time to think.
Con men continually develop innovative ideas to dupe unsuspecting investors, but regardless of how seemingly fresh their concept is, the same too-good-to-be-true promise is an inherent characteristic. In the end, to be a more vigilant investor, you shouldn’t only be aware of what’s legitimate from what’s not, but it’s equally important to be pragmatic in a financial sense.
Oh, and if you were paying attention and have read until here, you may have noticed that the 6th tip is missing. Actually, the 6th way to avoid scams is to read more articles here at Intellinvestors! 😉
Thank you for reading this article. If you have any questions or comments, post them below. Also, if you are looking to invest or trade with a broker, here is an article for you to learn how to select the best one. Click on the button below to read.
Edited by: MC Davila