Thursday, September 17, 2009

how to avoid falling into investment schemes

People sell anything these days but what catches our attention are opportunities to make money. But we must be careful in placing our hard earned money. They might be offering incredible returns but at what cost. Such high returns at regular intervals could probably be what is called a Ponzi scheme. According to the wikipedia: A Ponzi scheme is a fraudulent investment operation that pays returns to separate investors from their own money or money paid by subsequent investors, rather than from any actual profit earned. This is also called pyramid scheme, since what is paid to the top investors of the pyramid are the investments of those at the bottom and so on until the pyramid becomes too large and without new investors, it collapses. The title of this post is quite misleading because it is very difficult to spot these schemes. These are perpetuated by professionals, they have beautiful offices and your friends are also investing their money with them. It only becomes clear if we look at it in retrospect, when our investments with them have vanished.

Here are some ways to protect our investments:
1. Diversify, diversify, diversify. Even if an investment offers excellent returns, you should never place more than 20% of your money in it. So that if it crumbles, you will still have 80% left. This is hard because, human as we are, we have a strong tendency to be greedy. There are many stories of couples who place their entire retirement fund into a ponzi scheme. It gave them returns of 4% a month and this went on for 5 years before the operations collapsed and wiped out their money. These schemes feed on greed, giving investors regular returns and enticing them to place more money. It leads investors to feel that this could go on forever.

2. Be extra careful when you hear the words: GUARANTEED RETURNS. Legitimate investments move up, down and sideways. When someone offers consistently high returns, investigate the company, their prospectus, financial statements and ask the simple question: How do you make money? For all you know, the returns you are receiving are from other unsuspecting investors.

3. It does not mean that if your friends and associates invested their money with a certain person or company, you should also follow blindly. Always do your due diligence and get to know the company and the person before placing your money with them. If the investment fails, you can never put the blame on anyone else but yourself.

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