Ponzi Scheme Avoidance: Tip No. 1

Cliches become cliches in large part because they resonate with truth. Here’s one of the best known cliches in all of investing. “If it sounds too good to be true, it probably is.”

Most investors know that an investment’s return usually is commensurate with its risk. As a general proposition, higher return is accompanied by higher risk and lower return is accompanied by lower risk. Consequently, when someone offers you an opportunity to get an above-market rate of return on an investment that he or she claims is perfectly safe, that should sound too good to be true and almost certainly should be cause for suspicion, if not an immediate, “No thanks, not interested.”

Ponzi schemers seduce victims with above-market returns and often, in fact, with extraordinary returns. When an investment program strikes you as “incredible” or “fantastic” or “unbelievable,” remember what those words actually mean. The seller probably is not credible, the deal probably is a fantasy, and you can’t believe what you’re being promised.

Not long ago, we were representing a Cleveland, OH couple who had been ripped off by Frank Gruttadauria, one of the boldest Ponzi schemers in history. In the course of a client meeting, the husband told us that his brother also had lost some money to Gruttadaria, but wasn’t interested in pursuing a claim because the amount was relatively small and he was making such tremendous returns in a very exclusive limited partnership deal put together by some investment manager. The promised return was so phenomenal, we responded, “That sounds awfully hard to believe. If your brother isn’t worried, he should be.” Our client said, “Well, this guy has delivered on his promises. He seems legit.” He wasn’t. A couple of years later, the amazing deal had proven to be a Ponzi scheme, the general partner had been sentenced to prison, and our client’s brother had been victimized again, along with dozens of other limited partners.

So…Tip No. 1, the most important tip we can give you to avoid a Ponzi scheme, is that the more wonderful the deal sounds, the more skeptical you should be.