Wednesday, October 31, 2012

Ponzi - how it can pay an attractive return


A Ponzi is an investment scheme which pays an attractive return, way above what can be earned in the market.  The promoter of the scheme pays the attractive return by using the money invested by the new investors to pay the return to the old investors.

Due to the attractive return, the inflow of money from new investors far exceed the payout to the old investors, so the promoter is able to pocket the difference.

Right from the start, the promoter already runs a deficit. For example, the money owing to investors is say $50 million. Next month, $5 million is due to be paid out to the old investors. But if new investors put in $15 million, the promoter can pay out the return and pocket the difference of $10 million. The promoter now owes $65 million to the investors, but there are no funds to back up this obligation.

The old investors may find the return so attractive that they reinvest their savings on redemption.

A Ponzi will continue to grow as more money flows in. When the new money stops coming in, the promoter is likely to run away, leaving the investors with a total loss of their investments.

Read this story about how the Ponzi first started, by a person called Charles Ponzi. As he created this scheme, his name was given to describe the scheme.
http://en.wikipedia.org/wiki/Charles_Ponzi



3 comments:

Lye Khuen Way said...

This explanation need repeating to cohorts after cohorts of young adults.

As the saying goes, there is a sucker born every minutes.

A corresponding one would probably be, there are crooks born every hour.

zhummmeng said...

You are right that there is a sucker born every minute.
Despite so much education given by Mr. TanKL and other sites on finance and insurance you still get suckers buying all sorts of scam life insurance, from regular ILPs to wholelife to universal life.
No wonder the insurance agents never run out of suckers.
No wonder, knowing there are suckers, the insurance companies continue to roll whole life or endowments that pay as little as 1% above interest rate. And next year MAS has forecast that inflation will hit between 3.5% to 4.5%. You notice some single premium endowments pay much lower than the inflation and yet stoopid or suckers are sold by agents without the conscience.
You can vomit blood when you still hear one after another consumers got conned by insurance salesmen and women.

Terence Soon said...

Sunshine empire was exposed, but there still remains a few others. Singapore should immediately outlaw such practices, including all MLMs, and arrest all their chiefs.

Their distributors, while obviously wrong, are but young kids below legal age, or housewives with insufficient knowledge.

MAS has ALOT to do; the industry is far too corrupted. How can we possibly solve this problem?? No amount of investor alerts seem to get into the heads of people.

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