Every few years, we are introduced to a new investment scheme promising to double or triple our money. In the wake of the infamous Olint and Cash Plus scandals, we are still tempted to risk investing in the hope of seeing otherwise unattainable returns. Yet, in a few more years, those promises are followed by sentiments of distress from people who have lost all of their money.

Recognising the signs of a ponzi or pyramid scheme is the best way to avoid falling prey to them.

High Returns at No Risk

How much return on investment can you expect to see when investing with a bank or on the stock market? Two per cent? Five per cent? Ten per cent? Within the next quarter or the next year?

An abnormal figure would be a 300 per cent return within one week, as promised by the pyramid scheme Loom. Ponzi schemes Olint and Cash Plus offered their investors up to 120 per cent in annual returns. What many people don’t realise is that those unrealistic rates are quoted to lure potential investors. Nevertheless, early investors will see high rates of return because the person operating the scheme will use their own money to give the appearance that the investment is working. For the fraudster, using their own money earlier allows them to turn a larger profit later when there are more investors to steal from.

At the same time, be wary of the promise of “no risk”. Risk is unavoidable when investing and is proportionate to the amount of returns you want to see. In order to see 120 per cent or 300 per cent returns, your risk appetite has to be just as high.

Ambiguous Investment

When investing in the stock market, bonds or real estate, it’s clear where your money is going and where your returns are coming from. However, the same cannot be said when investing in a ponzi or a pyramid scheme. The fraudster will employ different methods to prevent investors from seeing how the scheme works, such as using confusing financial jargon, labelling their strategies as trade secrets or barring investors from viewing official financial statements.

David Smith, the head of Olint, described the ponzi scheme as a “private investment club” where he would pool investors’ funds to “engage in foreign currency trading”. This vague description is a prime example of ambiguity, another common method used so that nobody can say with certainty what their money is being invested in.

In reality, a ponzi scheme works by robbing Peter to pay Paul; using the money of later investors to pay off earlier investors under the guise of returns from a legitimate investment. In a pyramid scheme, each investor pays a fee to enter the scheme, which is used to pay older investors who are above them in the pyramid. In order to recover their investment, members must recruit new investors and move to a higher tier of the pyramid. Both schemes rely on new investors and a constant inflow of cash. When the pool of new investors dries up, the scheme falls apart.

Recruitment

Because pyramid schemes generate income from fees paid by new investors to enter the scheme, there is a heavy reliance on recruitment. Loom, a pyramid scheme circulated through social media and in particular WhatsApp, required investors to invite at least two people “to keep the loom going”.

However, recruitment is also used in a sales strategy called multi-level marketing (MLM), which makes this red flag difficult to spot. Both pyramid schemes and MLMs pay a commission for recruitment. The difference between an MLM such as Avon and a pyramid scheme such as Loom is that an MLM generates income from legitimate product sales. Pyramid schemes rely solely on recruitment fees. Pyramid schemes don’t have to involve a product, but some will in order to give the appearance of an MLM.

Licensing

If you have any suspicions about the legitimacy of an investment scheme, contact the Financial Services Commission and ask about the broker’s licence. Don’t be fooled by the supposed legitimacy of a company, as that does not automatically make it a licensed investment broker.