What is Ponzi Scheme Meaning: Understanding in Detail
A Ponzi scheme is a type of investment fraud where investors are lured into investing a significant amount with a promise of high returns either with little risk or none at all. The money taken from investors is not invested in any fund rather scammers use the invested amount to pay profit to early investors. This keeps going on in a cycle and is therefore considered a type of pyramid scheme.
How Do Ponzi Schemes Work
Now that you have an understanding of the Ponzi Scheme meaning, let’s understand how it works.
Ponzi Schemes usually have promoters who lure potential investors into putting their money in a fund that doesn’t exist in reality, with a promise to provide high returns in a limited time frame. The invested amount is then used by promoters to pay returns to early investors. Now, when these investors get their returns they are lured into believing in these schemes and they go on promoting the scheme to their friends and family. This is how the scheme continues and grows.
A common trait of these promoters is focusing on communities or groups to find potential investors.
Let’s take an example of Ponzi Scheme to understand it better: Say Mr A invests ₹1000 in a scheme and similarly Mr B invests ₹1000. The scammer pays ₹1500 to Mr A after getting Mr B’s invested amount and makes a profit of ₹500. The scammer then proceeds to lure Mr. C and the scheme goes in cycles.
The only difference is that these schemes have numerous investors and the invested amount is much more than ₹1000 which gives the scammer a wide window to use the money wherever they wish to.
Real-Life Example of Ponzi Scheme
Surprisingly, if you look for real-life examples of the Ponzi Scheme, you would come across multiple stories.
For instance: The Saradha Group Ponzi Scheme is something we all read about. A well-known name Saradha Group lured millions of investors to invest in Chit-fund with a promise of high returns and lower risks. In reality, the invested amount of new investors was just being used to pay off existing investors creating an illusion of profitability of the investment scheme. Saradha Group focused on investors from either middle-class or lesser-developed cities to take advantage of their lack of awareness. A few years down the line, Saradha Group collapsed leaving all those investors in distress as they lost life savings and were left with no remedy. Although the company was held responsible and criminal proceedings were conducted the lost money was never recovered.
This scheme and hundreds of others exposed the reality of concerned authority and the need for strict regulatory reforms that ensure that a Ponzi Scheme surpasses their evaluation.
Origins of the Ponzi Scheme
Before going ahead with the working of a Ponzi scheme, let’s talk about its origin.
In 1920, Charles Ponzi's name became extremely popular as he emerged as a billionaire by luring people to invest money in non-existing funds. In 1919, Charles Ponzi claimed to be an Italian immigrant who dealt with investments in international mail. At that time it was common for the government to offer local currency in exchange for stamps and Charles saw this as an opportunity. He would purchase postal stamps of foreign countries and hold them till the currency’s value increased to capitalise. He lured friends and family into investing money by promising them returns every month. Surprisingly, Charles was entrusted with approximately $51 million, approximately. He would use the money of new investors to pay off old investors. Although he made significant profit but soon went bankrupt. 1
His scheme of providing almost 50% returns in 90 days which got down to just 45 days grabbed attention and he was arrested. But it was after his name that schemes like these started being called Ponzi Schemes.
Additional Read: What is Demat Account: Importance, Features and Types
Different Warning Signs of a Ponzi Scheme
Ponzi schemes have looted numerous investors in India and abroad. While investors lost their life savings, scammers kept making huge profits. What makes a Ponzi Scheme scary is its appealing nature which can lure even smart and diligent investors.
However, now that these schemes are popular, so are their tricks and methods making it easy to avoid falling prey to a Ponzi Scheme.
Here are common signs of a Ponzi Scheme that works like a warning:
Remember that a simple rule of investment is that it comes with some level of risks especially if you are expecting higher returns. A Ponzi Scheme capitalises on an investor’s hope to eliminate this risk which also becomes the biggest warning sign. Be aware of schemes that promise high returns with little or no risks at all.
Another rule of the stock market is that it is volatile. Yes, the volatility can increase or decrease but the market is not stable throughout. So if an investment is promising consistently high returns, maybe it is time for you to be cautious and take a step back.
If your investments are not being recorded on any of the approved portals like a trading account or a demat account, it is a clear sign of suspicious investment. A Ponzi Scheme would not register your investment as it can invite scrutiny by the Securities and Exchange Board of India or other concerned authorities.
A company engaged in selling shares or inviting investments has to be registered with the SEBI. An unregistered or unlicensed seller/company is a red warning sign for you to be cautious.
A rule that applies to Ponzi Schemes and any other type of investment scheme is that you don't put your money into it if you don’t understand the scheme. Finding a fund secretive or has complex strategies? Take a step back, research, and perform due diligence before you decide to put in money.
An investment that does not come with its paperwork done to the T is in most cases a red flag. This is particularly true in terms of a Ponzi Scheme. The promoter/agent would avoid providing you with detailed paperwork, and this is your sign to step back.
Lastly, remember that scammers under a Ponzi Scheme would persuade you to delay withdrawing money you received as profit and ask you to stay invested for even better returns. Any of the above signs clubbed with difficulty in payment or cashing off is a warning sign.
What Should You Do If You Have Been Scammed by a Ponzi Scheme
Despite staying diligent, if you have fallen prey to a Ponzi Scheme, there is no need to panic. Here’s what you can do to avoid any further loss:
Document Every Transaction: Immediately, create a document of every transaction, including mail, SMS, letter, or any other evidence that you might have against the scheme.
Conclusion
A Ponzi scheme is quite common in India, and despite multiple warnings and awareness campaigns, investors keep getting trapped in such schemes. It is hard to blame a person when a scheme is so appealing, especially when the actual Indian stock market is volatile. However, through warning signs, investors can save themselves from getting trapped. Remember that investment requires diligence, understanding of the market, and a little appetite for risk to bring profit, and a Ponzi Scheme is nothing but just a scam.
Disclaimer: Investments in the securities market are subject to market risk, read all related documents carefully before investing.
This content is for educational purposes only. Securities quoted are exemplary and not recommendatory.
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