The old saying “if it’s too good to be true it probably isn’t” is all too easily forgotten when your investment just keeps on spinning out money. We”ve worked hard and have earned our good fortune we tell ourselves. And the perpetrator of a “Ponzi” or pyramid scheme will be the first to point this out as he or she congratulates you on becoming, at long last, a client in a very exclusive, very lucrative private investment-fund.
That’s how Bernie Madorff bilked individual and institutional investors alike out of $50 billion in history’s longest running, biggest ever Ponzi scheme. He made them feel special and he made them, on paper at lest, wealthier by the month, generating a 1 to 2 percent return every four weeks like clockwork year in, year out, buying large cap stocks and trading related stock-options. What he was actually doing was paying existing clients with the money new investors poured into his fund.
Charles Ponzi concocted the first notorious “pyramid” scheme back in 1920; it attracted 40,000 investors and had a capitalization of $15 million when it went bust later that year. Compared to Ponzi’s claim of a 50 percent return on investment in just 45 days, Madorff’s seem reasonable. Only they weren’t and never could be.
For markets never, ever behave orderly enough to make consistently high yields realistically possible. A steady-state flow of net returns is a red-marker: Caveat Emptor! Even returns on U.S. Treasury Bonds, the least risky investment there is, have fluctuated 5.8 percent from 1.6 to 7.4 percent in the last ten years, riskier stocks returns by as much as 15 percent. If it’s too good to be true it probably isn’t.
If the only financial statement you receive periodically comes from a fund’s manager and not from a recognized, independent brokerage house monitored by financial regulators, beware. Insist that all the securities invested in your name by this fund be held by a legitimate, independent institutional custodian, a Schwab or a TD Ameritrade for instance.
All the checks you subsequently write relating to your investment should be made payable for deposit only to that institution. If the fund manager asks that checks be written to him or her, it’s probably time to bail. If he or she asks for your blanket permission to disburse funds from your account, it’s definitely time to bail.
Finally, do your due diligence. Ask for specifics of what stocks, bond, commodities or options the fund invests in and what trading strategies it employs. If all you get in the end is a wink and nod suggesting insider information, some financial mumbo-jumbo about proprietary algorithms, or a testimonial-sounding recitation of famous clients, close out your account by the end of the business day.
Remember, you preserve your principal and your profits if you cash out of a Ponzi scheme early on when it’s still solvent. Stay in too long and you’ll be lucky to get a fraction of your original investment back after much legal wrangling.
Charles Schwab Corporation (SCHW) supplies securities brokerage services, banking, and a related financial product to individual and institutional investors mostly in the U.S., U.K. and Hong Kong It has a market capitalization of $15.7 billion.
TD AMERITRADE Holding Corporation (AMTD) provides common and preferred stocks, exchange-traded funds, option trades, mutual funds, fixed income, margin lending, and cash management services to individual and institutional investors. It has a market capitalization of $6.65 billion.