DOLLARS AND SENSE

Common sense answers to questions on personal finance

by Joe Plemon 

Q: Joe, I read about how Bernie Madoff cheated investors out of billions of dollars through a Ponzi scheme.  What is a Ponzi scheme and how can I avoid investment fraud? 

A:  A Ponzi scheme is a pay-as-you-go pyramid scam named after Charles Ponzi, who went to jail for his fraud in 1920.  Ponzi promised to double, within 90 days,  the investments of those who paid into his program.  Those first investors, were in fact, rewarded by having their investments double in 90 days.  Ponzi simply paid the first wave of investors with the money he received from a second wave of investors.  He then paid them with money from an ever increasing number of investors.  The scheme worked as long as the pyramid continued to increase.  However, once the pyramid stopped growing, there was no way to continue making the payments, since his scheme produced no new wealth.   

These four tips will help you avoid investment fraud:

1. Ask around.  Get referrals from people you know and trust.  An advisor they freely recommend is someone you should consider.
2. Get to know your advisor.   Don’t blindly trust him.  Ask lots of questions.   Remember:  you are interviewing him for a job, so make him earn your trust.  If he can’t explain investments in terms that you understand, walk out.
3.  Check his credentials.  Your broker should be a Certified Financial Planner (CFP).   You can verify the validity of his registration at www.cfp.net.  You should also check to see if he has had any complaints filed against him by checking www.finra.org (Financial Investment Regulating Authority) and www.sec.gov (US Securities and Exchange Commission).
4. Never pay the money directly to your advisor.   An advisor asking you to write a check directly to him is a huge red flag.  Your payment should be to the investment firm or the fund itself.