Shams, Scams, and Frauds: The Ponzi Scheme

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An earlier post looked at the “Pump and Dump” scam.  Now we’ll look at a gimmick of equally long pedigree in the world of fraud and theft, one made famous not too long ago by so-called financier and criminal, Bernie Madoff.  Unlike the pump and dump, the Ponzi scheme is harder to detect — so much so that Mr. Madoff and others who perpetrate such frauds frequently do so for years (decades in Madoff’s case) without any action or even suspicion by the Securities Exchange Commission (SEC) or other agencies that police financial markets and practices.  In Madoff’s case, the market found him out before the SEC even looked his way.

How Does the Scheme Work?

Named after Charles Ponzi, who ran a particularly famous version of the scam in the 1920s, this fraud really only looks like investing.  Little investing is involved.  The schemer presents impressive but fake investment returns in order to con new victims, whose money he uses to pay generous “dividends” to earlier investors, after, of course, taking a handsome rake off.  A Ponzi schemer can only keep up the scam as long as he can entice an ongoing money flow from new “investors.”

Ponzi criminals are usually exposed when they can’t get enough new victims to pay those “dividends” to the earlier “investors” or when enough people to try to remove their assets to meet some perhaps unexpected financial need.  At that point, everyone loses out.  The Ponzi scammer goes to jail and, because there are seldom any assets, the victims have no way to recover their funds.

Bernie Madoff

  This was the case with the famous and more recent Ponzi run by Bernie Madoff.  He managed to carry on his show for decades and seduce many presumably experienced financial people who should have known that his dazzling advertised returns were too good to be true. No doubt Madoff succeeded in getting many new clients, because he could boast about all the prominent people he had already taken in and whose money he had already captured.  Madoff not only tricked investors, but he also fooled the authorities and financial journalists who also should have known better.  He was quoted frequently in the financial media and even served for a time as president of the American Stock Exchange.

It all unraveled in the financial crisis of 2008.  The huge financial strains of that time exerted two different pressures on Madoff.  First, fewer people had money to “invest” with him, and second, long-time customers, facing their own financial problems, needed cash and tried to withdraw their funds. Of course, Madoff had nothing for them, especially because he was having trouble finding new “investors.”  When it became obvious that he could not honor their withdrawal requests, the SEC became involved and only then did criminal prosecution begin.  As is always the case with Ponzi schemes, the victims lost everything.  Madoff’s personal wealth, as great as it looked, could hardly cover even a small piece of their losses, and many of his victims lost much of their wealth.  Madoff went to jail.  The authorities moved on — as if they had done their job.

Protecting Yourself

The only defense is to always remember the old Wall Street saw: “If something looks too good to be true, it is.”  No one, not even the most gifted investor, can produce superior investment performance year after year without pause, as Madoff and other Ponzi schemers claim, or can make money in every down market.  If you keep that in mind, you can avoid being taken in, no matter how many of your friends, colleagues, and prominent fools claim the thief’s brilliance, no matter how tempting it is to secure the gains the Ponzi schemer promises which, in the end, he or she can never deliver.


First Steps for a New Investor

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For many, investing seems to happen in a foreign place where the inhabitants speak a strange language.  Most don’t know where to begin, and it’s easy to understand why:  They don’t teach this stuff in school.  One thing, however, is clear.  Unless you entered life with a trust fund, investing starts with small savings and the cultivation of the savings habit.  So let’s start at the beginning, with techniques for saving and how to plan your investment scheme.

Developing the Saving Habit

Too many of us procrastinate.  It’s easy to convince yourself that setting aside only a few dollars will make little difference compared to some “urgent” household or personal need. While sometimes these needs can be genuinely important, most are usually an excuse to put off saving and seek immediate gratification instead.  It might help you resist temptation to realize that every dollar you save each week or even each month will start growing beyond what you are depositing, what I call building on itself.  And soon the increased savings will offer their own gratifications.  The effort will also help you strengthen your saving habit, which, in most cases, is more than half the battle.

Here are seven tips to get in the habit of saving:

  1. Put aside all your loose change in a jar at the end of the day.  Better yet, add a dollar or five dollars into the jar each evening.  Such small amounts can quickly become a significant contribution to your savings. And most of the time it’s money that you won’t miss.
  2. Leave your credit cards at home.  Paying with cash will put a cap on how much you spend at a given time.  And if you have to run home to get the card, it might give you time to rethink an unnecessary expenditure.
  3. Contribute to stock purchase plans and reinvest the dividends.  Many companies allow employees to use part of their paychecks to buy the firm’s stock through automatic deductions.  This is money you might otherwise spend.  If you are in such a program, reinvest the dividends instead of taking them in cash.  This is a good rule to follow with any stock you own.
  4. Consider savings as you would any regular expense — like bills from the electric company or mortgage payments.  Set a dollar amount, say 1 percent of your take-home pay, or better yet 5 percent if you can, and “pay” that into your savings account each paycheck.
  5. Use automatic savings plans.  Some employers offer plans that take a designated amount of your paycheck to buy you U.S. government savings bonds (more on these in later posts).  Ask your bank if it can automatically transfer a designated amount each month from your checking to your savings account.
  6. Keep putting money aside even after you have paid off a loan or a mortgage.  Continue to write a check every month for the same amount, or at least a good portion of it, and put it into your savings.  This is money that you have long learned to live without, so you can increase your wealth painlessly.
  7. Occasionally give yourself a reward.  Saving is hard, and its payoff is often years in the future.  So once or twice a year, designate one month’s set aside for a little extra spending. Take the family out to dinner or buy something special for yourself or someone you love. It will give you something to look forward to that is nearer in time than the ultimate use of your savings.

Make a Plan 

Though saving and investment plans vary as much as individual desires and goals, one element should appear in every plan: an emergency fund, a pool of cash for unforeseen events, like sudden medical problems, appliance repairs, or possible unemployment. Ideally, set aside 3 to 6 months income to cover such needs. The money should go into what financial people call a “liquid vehicle,” one that you can access immediately such as a bank savings account or other easily accessible vehicles that I will describe in subsequent posts.  Once in place, this saved money will work for you: by building on itself through bank interest and by protecting you and your loved ones from harm.  Importantly, it will also give you confidence to take the next steps.

Once you have established this basic source of security, and the habit of saving, you can begin focusing on personal wants and needs. There is no right answer here. Much depends on your age, income, family circumstances, and interests. The money should serve your desires as well as your needs.  Some goals are very long term, like a young person saving for retirement.  Others are not quite that far off, like college for a newborn or buying a home, or starting a new business.  Still others may be more immediate, like buying a new car or kitchen.  All are legitimate, but each requires a different investment strategy.

To organize your thinking, create a small chart like the one at the end of this section.  It can link each need to an investment goal.  List your savings goals on the left.  I offer a few examples.  Yours will be different.  Next, fill in the likely cost.  You can research this on the Internet but in the case of housing for example, you may also want to do a bit more research about what it will cost when you are ready to buy.  Next, determine when you expect to need the money.  Count the months to that date and divide the cost by the number of months to see how much you’ll have to put aside each month.

The “months to go” will reflect where you are in your financial life.  A parent starting a college fund for a newborn, will be looking at an 18-year time horizon (216 months) before he or she needs the money.  Other goals will reflect more personal preferences.  If you think your car will last only another year, you’ll have to save for the replacement in only twelve months.  Plans to marry in two years will give you 24 months to accumulate the desired funds.  If planning reveals that your goal requires more savings a month than you can support, you might have to adjust your lifestyle, delay the target date, or even abandon this particular goal.  Harsh as these tradeoffs may seem, they are simply facts of life that no one can ignore.

                                                               Planning Guide                   

Goal Cost Date Months to Go Set Aside Each Month
Car Purchase:
Purchase of Home Entertainment System:
Money for a Good Vacation:
Funds to Buy a New Kitchen:
Purchase of a Home:
Money for a Retirement Nest Egg:  



Executing the Plan — Time is on Your Side

The further in the future your target date is, the less harsh the tradeoffs.  Remember that everything you save earns interest or dividends that over time will build the fund alongside your monthly savings contributions.  Because you are paid this interest not only on your contributions but also on the interest previously accumulated, what financial people call compounding, the longer you can wait before using the money, the more your savings or investment plan will help you accumulate.  These earnings will defray the burden of the monthly set aside.  Two examples:

One:  You need $20,000 for a car and a year to get the money.  Here, returns from investments will contribute only a small part of the total. In this example, it will require a set aside of about $1,629 a month.  Even if the savings account pays 5 percent, it would earn only about $88 over the course of the year. So most of the money would have to come from your monthly savings contributions.

Two:  With longer-term projects, however, earnings from savings and investments can contribute considerably more.  Say you are one of a newly married couple that wants to buy a $250,000 home in 15 years. To meet your goal entirely from setting money aside, you would have to save $1,389 a month.  But after five years of saving at that rate, your accumulated investment account would amount to $83,333.  At 5 percent interest, it would earn $4,723 a year from then on and more each successive year from the accumulated interest as well as your contributions.  That income alone would effectively substitute for over three months of future savings every year.  After ten years, you would have accumulated $166,666.  At a 5 percent interest return, it would earn $10,784 a year, enough to pay over seven months’ required savings.  These would amount to a major contribution toward your goal of home ownership. This is why time is on your side. The table at the end of this post lays out the accumulations of savings and interest year by year.

With even longer time horizons — say retirement savings — the contribution from investment income becomes even more significant. Over 30 years, in fact, the accumulated earnings from the investments would actually exceed the total of monthly set-asides.  In the example of the home purchase, the annual earnings from accumulated savings already by the fifteenth year would have come close to surpassing the annual savings need originally calculated.


                                    Interest Earnings Help Savings Accumulate

Years Yearly Savings Set Aside[1] Earnings on Savings[2] Total Available[3]
1 $16,667 $16,667
2 $16,667 $833 $34,167
3 $16,667 $1,708 $52,542
4 $16,667 $2,627 $71,835
5 $16,667 $3,592 $92,094
6 $16,667 $4,605 $113,365
7 $16,667 $5,668 $135,700
8 $16,667 $6,785 $159,152
9 $16,667 $7,958 $183,776
10 $16,667 $9,189 $209,632
11 $16,667 $10,482 $236,780
12 $16,667 $11,840 $265,285
13 $16,667 $13,264 $295,216
14 $16,667 $14,762 $326,644
15 $16,667 $16,332 $359,643


[1]$1,389 a month for 12 months = $16,667.

[2]Five percent on the account amount of the previous year.

[3]Savings set aside plus the earnings on the accumulated savings.


Shams, Scams, and Frauds: Pump and Dump

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The best protection against any investment scam is to remember that if an investment looks too good to be true, it almost certainly is.  Most investment frauds lure their victims by promising returns that are simply unbelievable. A good investment track record is attractive.  A fabulous one is suspect.  When offered something that seems extremely desirable, always ask yourself:

  1. Why would someone who can secure such returns want to share them?
  2. Why would that person want to share them with me in particular?

An effective shyster will have plausible answers to these questions and others, but a little thought should revel the danger in what the scammer is proposing.

It is simply impossible to itemize all the scams set to trap the unwary.  They are as broad and varied as human imagination.  Here I outline one of the most common and so most destructive:

How Pump and Dump Works 

This is an old game.  The swindler is frequently a broker who begins by buying a thinly traded stock with the firm’s own funds.  Because the stock is thinly traded, his or her buying pushes the price up smartly.  At the same time, the broker’s sales force promotes the stock as a great buy. Frequently, the con involves glowing reports placed on the broker’s website.  The unsuspecting — day traders and others — read the glowing reports or hear the sales pitch over the phone, see how the price is rising, and put in their orders.  This additional buying pushes the price up even faster, giving the promoter an ample profit on his or her earlier buying, at which time the con artist sells and ends the sales promotion.  Those sales and the sudden end to the hype reverses the upward momentum of the stock, and the price falls, leaving the people who succumbed to the con with losses.

Hollywood has produced several films about pump and dump artists. They typically glamorize what is in reality a grubby business, but behind the slick veneer Hollywood does show the fundamental nature of the abuses, the deceit, and the complete disregard of others and for common decency.  These films also show more sex and better-looking people than exists in the real world, especially in such ugly operations.

Targeting the Most Vulnerable

The saddest part of these swindles is how they target those least able to cope with the losses — financially unsophisticated people, especially the elderly who may have substantial savings but not much financial experience or expertise.  Court cases show the lengths to which some of these con artists go to target their promotions:

  • They will read obituaries to identify surviving spouses who might have received a large insurance check and at the same time face emotional strains that make the person easier to confuse. (See an earlier blog on coming into money.)
  • These swindlers are well aware that retirees often get substantial sums from retirement plans or from the sale of a family home, larger amounts than these people have ever handled. (See an earlier blog on coming into money.)
  • The con artists are also well aware that the elderly often live alone and have no one to help them think twice about an impulse planted by an Internet notice or an enthusiastic phone call.

How to Protect Yourself

Whether dealing with this particular game or one of hundreds of other scams, people can protect themselves.  Here are half a dozen tips:

  1. Remember again that any investment that looks too good to be true almost surely is.
  2. Collect names and addresses. Visit the promoter’s office. If the person on the other end of the phone refuses or makes excuses, take that as a bad sign.
  3. Insist on getting details in writing. Ignore claims about too much urgency for such things.
  4. Never give information about yourself, your bank account or your finances to anyone who has solicited you whether on the phone, via email, or any other way.
  5. Check on the firm soliciting you. The Internet makes this easier than it once was.
  6. Check with the authorities:  
    • See if the broker soliciting your is registered in the state where you live.  The North American Securities Administrators Association can help with this.
    • The SEC requires securities firms to register.  It’s website can provide information.
    • The SEC also provides information on brokers that have run into trouble with the authorities in the past. You can check this out at
    • The SEC also offers guides on what questions to ask and how to file a complaint.
    • If you think you have been swindled, the Consumer’s Action Handbook from the Federal Citizen Information Center can guide you through the steps to take at


How You Should Choose a Bank

Choosing a Bank

For this post, I thought it would help to go back almost to the beginning.  Your first step, after you have saved a bit (techniques for that in another post) is to put that money to work for you where it can earn something.  A savings account at a bank is the obvious, though not the only place.  Even among banks, not all are the same.  Here is some guidance for making your choice:


It would be foolish to choose a bank simply because it is near your home, but it is a consideration nonetheless.  While factoring in this convenience, also consider if that bank has branches near where you work.   That may be more important, since you are more likely to be there when the bank is open than at home.  Find out if the bank has branches in other cities, especially those that you visit often.

What They Pay

These days, banks offer little interest on savings accounts, less than 1 percent, in fact, and in some cases considerably less.  That will change. In time, interest rates will rise. The Federal Reserve, or Fed, as it is called in financial circles, has plans to raise them, perhaps to 3.0 percent or higher.  Small savers will benefit as that occurs, because the banks will respond by raising what they pay on their accounts.  But that will take time. Savers for now have no choice but to accept low rates. Still, there is more to choosing a bank for your savings than just the rate paid or the convenience of a branch.

Fees and Services

To make your decision, you should check out the banks in your area with a personal visit.  Talk to the person in charge of new accounts.  Describe your financial needs and listen carefully to his or her responses.  Among the issues the bank’s representative will describe, or should, are the conditions attached to newer accounts and what other services the bank offers.  Take notes and gather all written material available at the bank and on the Internet.  Study these and make comparisons of each bank to the others.  Here are matters on which you should focus:

  • Minimum deposit requirements.  The bank might pay different interest rates on different accounts, usually higher for those that require higher minimums.
  • Online services.  Almost all financial institutions these days have online services, but not all reach the same standard.  See if the bank allows you to deposit checks online, arrange bill paying, and other services.  If it does, this could save you a lot of time.
  • Help desk.  Find out if you must visit the bank in person if you have a question or whether it has Internet or telephone service. Usually, the level of service rises with the size of the account.
  • Penalties.  Banks often charge fees or reduce your interest if your balance falls below a certain amount.  This has become especially important in these times of low interest rates.  Identify how large these penalties are and when the bank would levy them.  This will not only prepare you, but it will help you plan to avoid such expenses. Penalties might also occur if you fail to make deposits or withdrawals for a long time, or if you make a lot of small withdrawals.  Find out and plan accordingly.
  • Yield.  Banks typically advertise two interest rates paid on deposits: the “annual rate”and the “effective rate.”  The difference reflects how often interest is calculated and credited to your account.  The effective rate includes a consideration of how frequently the bank credits your account with the interest.  The more often it does so, the more each calculation will earn interest on the interest already paid.  Find out.
  • Automatic savings.  Some banks will transfer a specific amount from your checking account to your savings account automatically each month. Find out if the bank offers such a service and if it involves a fee.
  • Favorable loan, credit card, and mortgage rates.  Some banks offer depositors favorable terms and rates on loans or mortgages.  Find out if you have access to such an arrangement. It might involve a larger minimum deposit.
  • Currency exchange.  The most cost effective way to get foreign currency is through an ATM in the country you are visiting.  Not all banks charge the same rates and conversion fees on such transactions.  Especially if you expect to spend significant time abroad, find out what each bank charges.
  • Overdraft charges.  Most banks will enroll accounts in their overdraft program.  It automatically advances you funds to cover checks you accidentally write in excess of your balance.  Without such an advance, your checks might “bounce” or, even if the check is honored, face a hefty fee. An overdraft program can protect you.  Find out how it works.  The program itself very likely has charges.  Find out what they are, under what circumstances the bank might charge you, and how quickly the bank will notify you so that you can take action to minimize any costs.  The best protection, of course, is to keep your checking account balanced and avoid overdrafts altogether.
  • Fees on automatic teller machines.  These have largely disappeared, but check to make sure.  Also, find out what fee the bank charges to use the ATMs of other banks or to use a credit card at the ATM machine.  Here are three additional tips on the use of ATMs:
    1. Each bank will set a limit or how much cash you can withdraw from an ATM at any one time. You should know this to calculate how many trips to the ATM it will take for you to amass larger amounts should you need them.
    2. Since most banks post interest at 3:00 pm each business day, try to make your withdrawal later in the afternoon so that your interest calculation for that day will occur on as much money as possible.
    3. All ATMs ask you to create a personal identification number, or PIN, that you must key into the machine to do the transaction.  Never give your PIN to anyone. Nor should you keep it anywhere on your person.  It should be easy to remember.  Do not use your birthday.  Hackers are onto this practice.


Make sure any bank you consider is federally insured. The Federal Deposit Insurance Corporation (FDIC) insures deposits up to $250,000 per depositor, no matter how many accounts you have with that bank.  For more information, visit the FDIC website,  The FDIC also provides information on banks’ relative financial strengths.  The Federal Reserve, which is the country’s primary bank regulator, runs a series of what it calls “stress tests” on how each bank would cope in a difficult financial environment.  Its website,, and financial media cover the results of these tests thoroughly.  Credit rating agencies, Moody’s, Standard and Poor’s, and Fitch, will, for a fee, provide information on bank finances.  Visit their websites:, and The private firm, Veribanc, also reports on bank safety ratings,

Which to Pay First

Which to Pay First

In response to my last post about what to do with surplus cash, an insightful reader asked whether it is best to pay off credit cards first or student loans.  Definitely, pay the cards first.  The most onerous student loan debt carries a lower interest rate than the least burdensome credit card.  Pay the cards off first, starting with those that charge the highest rates.  Only then should you turn to the student loans.

Student loans, burdensome as they are, often carry attractive terms.  In such cases you might consider investing the surplus cash and using the income from those investments to meet the regular student loan payments.  This way, the student loan payments cease to burden your everyday income, presumably from your job, and possibly even earn a little extra.  If you pay off the student debt, you do, of course, get relief, but no chance of that little extra from your investments.  With credit cards, the cost of borrowing is so high that there is no chance investing what would pay them off can earn more or even enough to cover the cost.  Best to use the surplus cash to pay off the cards as completely as you possibly can.

This was a good question, I look forward to others from other readers. 

So…You’ve Come Into Some Money…

So...You've Come Into Some Money?

Just suppose you receive a windfall: an inheritance, a legal settlement, or the transfer of pension funds when you retire.  Though more money is always better than less, such money flows do impose hard decisions. Many people feel insecure about what to do.  They frequently don’t know what decisions they need to make.  Here are the necessary steps to guide you:

First Steps

First, decide whether the windfall is sufficient to change your lifestyle or simply improve it.

Rule of Thumb: You need investable funds amounting to between 15 to 20 times your annual income in order to quit your job and pursue a life of leisure.

If the windfall and your other savings approach such an amount, you must take two further steps:

  • See an accountant or a tax lawyer to understand the tax implications of the money you have received.
  • Find a reliable financial planner to invest the funds in a diversified conservative portfolio such that it can securely support your new lifestyle. (In later posts I will discuss how to build such a portfolio.)

Two Following Steps

If the windfall does not come up to 15-20 times your yearly income, you will need to make some perhaps difficult personal decisions for yourself and/or your family:

  • Pay off your credit card debt. Interest charges here can be the most onerous short of a loan shark.  The most effective thing you can do with any surplus funds is to discharge these obligations.  Start with the credit cards that charge the highest rates.  (This figure should appear prominently on your card statement.)
  • Identify your critical spending needs. These would be the things you wanted to do before the windfall but couldn’t afford. You may need a new car or a second car. Your home may need repairs you have had to put off.  Perhaps your family or friends need a helping hand.  You, your spouse, or significant other may need a good vacation.  This is a partial list, but it should give the idea. After you’ve made the list, estimate the costs and then put those monies in a safe, relatively liquid account from which you can quickly withdraw them.  (In future posts, I’ll examine such accounts and discuss how to choose one that is best for you.)

Three Additional Decisions

If funds remain in the windfall, you will need to decide three big matters:

  • The Mortgage: If you own your home, you may want to use some of the funds to pay off the mortgage. How much depends on how much you can expect to earn from investing the funds.  If the investments earn less after tax than the interest on the mortgage, then the windfall is well used to pay it off.  If those investments can earn more, then you would do better to invest the funds and maintain the mortgage.  If the difference is close, your desire for security may reasonably sway you to paying it off.

Here’s an example.  Say you have inherited enough so that after “critical expenses” you have $250,000 left.  Say also you have an outstanding mortgage on your house of just that amount and the interest is 5 percent.  The mortgage, aside from payments on principal, costs you $12,500 a year.  If you are taxed at about 30 percent and deduct the interest expense from your tax bill, the after-tax mortgage expense comes to $8,750 a year.  At the time of this writing, an investor can reasonably expect a conservative portfolio to return about 6 percent a year––about $15,000 on the $250,000 windfall.  You will pay 30 percent in taxes ($4,500), giving you an after-tax return of $10,500 a year ($15,000-$4,500).  This significantly exceeds the after-tax annual mortgage expense, so unless owning the house outright is very important to you psychologically, you would do well to leave the mortgage in place and invest the money.  Of course, this is just an example.  Each person or family has specifics that could change the conclusion.

If you are renting or own a place that seems inadequate to your needs, you can legitimately use the money to buy a better place.  How much you dedicate to this–– whether you buy outright or put it down on a mortgage––hinges on the calculation just described.

  • Educating the Kids: A child’s education involves a simpler calculation.  You should have an idea what schooling after high school will cost, and how many years you have to accumulate the funds.  Assuming an annual investment return of 6 percent, you can calculate on any computer or business calculator how much you need to put to work in an investment to accumulate to what you’ll need when your child is ready.  This will tell you how much of the windfall you will need for this purpose.

Again a numerical example might help clarify.  Say you have one child who is five years old when you receive the windfall and that so far you have saved nothing for his or her higher education.  You estimate that by the time your child is ready to attend a state college in some thirteen years, the cost will be $30,000 a year––$120,000 for four years of study.  At 6 percent a year, the calculator will tell you that some $56,000 put to work in investments today will accumulate to what you need in 13 years.  Now you know what portion of the windfall need to go to the college account.  (More specifics on these in a later post.)

  • Retirement Savings: Funding for retirement is the most open-ended question.  Any investment you make instead of paying off the mortgage will contribute to your retirement.  Depending on your age and nearness to retirement, the amounts needed will vary, as will the appropriate kinds of investments.  (A future post will cover this material.)  But generally there is more flexibility here than with the mortgage or school decisions.  Of course, the bigger your retirement pool of assets, the better, so always dedicate as much as you reasonably can to retirement.  You may want to pay for your child’s education, but at the same time you probably don’t want to rely on support from your offspring in your old age.