Every year we have clients and friends come into the office or give us a call with a deal that seems just too good to be true. As you probably expect, most of them actually are too good to be true. It’s funny though. As you are sitting there reading this you are probably thinking, “I’m too smart to fall for an investment scam.” However, we see smart people fall for these scams a lot.
One reason I think we are sometimes susceptible to these scams is that we want to attribute altruistic motives to people that we meet. We are too trusting of the people that we meet. Another reason people fall for these is a little more sinister: greed. We all want to make that one great investment that sets us up for life.
One of the most common investment scams we see are stock fraud scams. These are also sometimes referred to as “Pump and Dump” schemes. The way it works is you receive a call or an email or see a posting online for a “microcap” or penny stock that is very promising. The message is usually that this company is on the verge of some break through that will send its stock soaring. It seems like a solid company, so you buy some shares. What is actually happening, though, is that the people promoting the stock have already purchased shares for themselves before they start marketing the company to others. When other people start to buy the stock, the prices goes up. Victims view this a proof that the stock really is going places. Unfortunately, the scammers are one step ahead. Once they’ve gotten the price to rise substantially, (that’s the “pump” part) they sell their shares (that’s the “dump” part). The price plummets, and everyone not in on the scam loses most or all of their money.
This is one of the scams depicted in the movie The Wolf of Wall Street. We sometimes get calls from “investor relations” firms that want to convince us to use these stocks with our clients. In the 23 years that I’ve been in the investment business, I have never seen any of our clients make money in penny stocks.
Another very common investment scam is the Ponzi or pyramid scheme. The promise of the Ponzi scheme is a high return on a group investment. Each participant is encouraged to bring in additional investors. The truth is that there really is no investment, money from later investors is simply being paid out to earlier investors as “returns.” Eventually, the pyramid runs out of new investors and it collapses. Later investors are wiped out. For example, let’s say a fictional investor we’ll call Steve has $25,000 to invest. He is approached by someone with a very high return investment that carries no risk. Steve is skeptical, so he gives $5000 to try it out. After a month, he gets a check for $2500 – a 50% return in just a month. Steve is convinced, so he invests the remaining $20,000. The next month Steve receives a check for $12,500, anther 50% return within a month. Now Greg really feels confident. He takes out a $100,000 home equity loan and invests that money. At that point the scam is complete and Steve never sees the person again.
This is essentially the scam Bernie Madoff was running. He was taking investors’ money and mailing them fake statements showing that they were making fantastic returns. When an investor wanted to withdraw some or all of his money, Madoff sent new money from other investors.
There is not enough space in this column to cover all of the investment scams that are out there. Even if we had unlimited space, we couldn’t cover them all because new ones are invented all the time. Prime bank schemes, promissory notes, foreign lotteries, and sweepstakes are a few that we’ve seen lately. What they all share are promises of unusually high returns with little or no risk. You can protect yourself by asking a lot of questions and approaching any new investment with skepticism. Another way to protect yourself is by getting a second opinion from someone you trust. That person doesn’t even have to be a financial expert, but a CPA, attorney or financial advisor could certainly help too.
For more information, you can listen to the podcast of Smart Money Management radio show on this topic, along with others, at www.alderferbergen.com.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.
Securities and financial planning offered through LPL Financial, a registered investment advisor. Member FINRA/SIPC