How Do You Define A Ponzi Scheme? I would doubt I have many readers who aren’t aware of the definition of a Ponzi scheme; however, I will define it briefly for those who aren’t sure. In recent weeks it seems like each week you hear of an investment advisor who confesses to operating one of these schemes. The modus operandi goes like this: The advisor solicits clients by promoting a long track record of successful investments. This solicitation is usually accompanied by a list of satisfied clients who have benefited by this approach. While these satisfied clients have received excellent returns, the returns do not come from a successful strategy but from subsequent clients who’s funds are not invested but diverted to furnish returns to the previous client. This can last for a long time as long as new clients keep investing their money. Eventually, the system has to come to an end, as the current clientele grows so large that not enough new clients can be located to furnish their returns. When the scheme is finally brought to light, losses to clients can be astronomical.
How Do You Avoid Ponzi Schemes? Practitioners of Ponzi schemes include names like, Donahue, Hoover, Madoff, and Stanford. There are undoubtedly others who haven’t been discovered yet. Here are some of the characteristics they have in common. 1. High lifestyle including things like large boats, airplanes, multiple luxurious houses, and lavishly decorated offices. 2. Claims to have a unique insight into the markets. 3. A list of satisfied clients. 3. Consistent above market returns. 4. An intense sales approach that offers you membership in an exclusive “club” that isn’t open to just anyone. 5. They are prone to anger for those who decline to invest or who need time to think about it. Allen Stanford claimed to be a knight, owned a lavish offshore suite of offices and a bank and went by the title of “Sir Allen.” He tried to turn himself in last week but was turned down because the investigation is still incomplete and no warrant has been issued for his arrest. If you run into a prospective advisor who has two or more of these characteristics, back off in a hurry.
How Do Ponzi Schemes Get Started? I have often been amazed that advisors start these schemes despite an almost certainty of eventually getting caught. In a recent article posted on CObizmag.com,, Stephen Mauzy, Chartered Financial Analyst, offered some insight into how seemingly intelligent advisors end up in these quagmires. In the beginning many of them have an idea for a strategy that seems likely to work. It usually does work for a period of time. Unfortunately, virtually any strategy will eventually fail for a period of time, no matter how well it is thought out. When this happens some advisors, driven by ego, greed, or pride, resort to Ponzi schemes with the intent of making the clients whole again. Some may even be successful but the majority end up on an irreversible downhill slide. I recall, one Denver advisor pleaded with the judge for a lenient sentence so he could earn the money to repay all those who were cheated. The judge didn’t fall for this and responded with a 100-year sentence.
Investing Mistakes Are Unavoidable. In the late 90’s, I came to the conclusion that high dividend stocks provided lower volatility and cash flow for reinvestment or use in funding retirement expenses. This approach worked well throughout the late 90’s and early 2000’s. Using this approach, I was able to avoid the “tech wreck” of the early 2000’s and produce relatively consistent above market returns. While I never claimed that this strategy would always be successful, I was surprised when this sector was among the hardest hit in the recent debacle. Although, I still believe this strategy will ultimately outperform the others for clients who must draw income from their portfolio and I have never been tempted to try to placate clients by lying to them, I can certainly see how some might be short sighted enough to resort to these schemes. I will use this humbling experience to strive for more refined strategies that minimize the effects of the inevitable mistakes of the future.
No comments:
Post a Comment