Spotting scams and bad deals
Learn the one question that exposes most financial fraud, the pattern behind schemes that pay old members with new members' money, and the checks to run before any money leaves your hands.
THE ONE QUESTION
Where does the money come from?
Every honest return has a source you can name out loud: a company's profits, rent from a tenant, interest from a borrower, a price somebody else agreed to pay. If nobody can name that source in a sentence you understand, there may not be one. Money does not appear. It is always moved from somewhere, and when you can't see from where, there is a good chance it is being moved from people like you.
"Arbitrage." "A proprietary system." "Our contacts in the market." These are not answers. They are ways of ending the conversation, and they work because most people are too polite to ask again.
Ponzi scheme
An operation that pays earlier investors out of the money put in by later ones, while producing nothing itself. It is named after Charles Ponzi, who ran one in the United States in 1920. It works perfectly and pays exactly on time, right up until new money slows down. Then it stops paying, all at once, and almost nobody gets anything back.
Early payouts are not evidence that it works. They are the marketing budget. "My cousin took his money out fine last year" describes the mechanism, not a safety check.
Check yourself
Leila is offered a scheme paying 8% a month, "guaranteed". She checks, and three people she knows have been paid on time for a year. What has she actually verified?
- That the scheme is real, since the payments genuinely happened
- That her own money would be safe, because she personally knows the people involved
- That the return is sustainable, because a whole year is a serious test
- That it pays out, which is exactly what a Ponzi scheme does until new money slows
Show the answer
That it pays out, which is exactly what a Ponzi scheme does until new money slows
Right. Paying out on time is the one thing this kind of scheme does reliably, because those payments are what recruit everyone else. It continues until the inflow slows, and then it stops for everybody at once.
"Guaranteed 10% a month"
What that actually means over time
one year 1.10^12 = 3.14 -> +214%
two years 1.10^24 = 9.85
five years 1.10^60 = 304.48
So 10,000 would become
after 1 year 31,400
after 5 years 3,044,800Anyone who could really do this would not need your money.
Within ten years they would be richer than most countries.This is the test for any guaranteed high rate. Run it forward five years and ask whether the world it implies is a world that exists.
Check yourself
In a country where prices rise 40% a year, an ordinary legal bank deposit can pay a rate that would look like an obvious scam somewhere else.
Show the answer
True
True, and it is why a big number on its own proves nothing. Where prices rise 40% a year, 45% is barely above standing still. What makes a rate a red flag is the company it keeps: the word guaranteed, a source nobody can name, and a rate far above everything else on offer in the same place at the same time.
The signs, roughly in the order they show up
- Guaranteed and high, together. Those two cannot both be true. A guaranteed return is the lowest return available anywhere, because certainty is the thing you are paying for.
- Urgency. A closing window, the last few places, a price that rises on Friday. Pressure exists to stop you checking, and nothing legitimate is damaged by you taking a week.
- You are paid for bringing people in. If any part of your return depends on recruiting, the recruits are the product, and to somebody above you, so are you.
- Nobody can explain how it makes money in words you understand, and asking is treated as rudeness or as an insult to the person who introduced you.
- Getting out is hard. Withdrawals need approval, carry a penalty, or are always possible "next month".
Check yourself
Red flag, or a normal part of a legitimate offer?
- "Guaranteed 6% a month, with no risk at all"
- A written document setting out what can go wrong
- "Only four places left, you have to decide tonight"
- You get paid a share of whatever the friends you bring in put up
- The firm is registered with the financial regulator where you live
- A clear answer to what happens if you want your money back in March
Show the answer
Red flag: "Guaranteed 6% a month, with no risk at all", "Only four places left, you have to decide tonight", You get paid a share of whatever the friends you bring in put up
Normal: A written document setting out what can go wrong, The firm is registered with the financial regulator where you live, A clear answer to what happens if you want your money back in March
Check yourself
A cousin invites Omid into a group he has already made money from. Members earn a share of whatever the people they introduce put in. The cousin is sincere and really has been paid. What is the strongest reason for Omid to stay out?
- His cousin may be lying to him about having been paid
- The returns are probably lower than advertised once the group takes its cut
- If the payout depends on new members, the members are the only source
- He does not know enough about investing to judge a scheme like this for himself
Show the answer
If the payout depends on new members, the members are the only source
Right. When the payout depends on recruitment, the money has exactly one source: the people recruited. The cousin being sincere and genuinely paid changes nothing about that arithmetic, and it is why these arrive through people you trust rather than through strangers.
Two ways the same money gets asked for
A real offer
Names what you would own. Names what can go wrong, in writing. Is happy for you to take a week and to ask somebody else. States what it costs every year. Tells you plainly how to get your money out and how long that takes.
A pitch
Talks about how much, and about who else is already in. Answers questions about risk with reassurance instead of detail. Needs an answer this week. Treats checking as disloyalty. Goes vague at exactly the point where you press hardest.
Before any money leaves your hands
- Say the source out loud
In one sentence, where the return comes from. If you cannot say it to someone else without using the seller's own words, you do not understand it yet.
- Check the registration yourself
Almost every country has a regulator that licenses firms taking the public's money. Look the firm up on the regulator's own site, not through a link the seller sent you.
- Ask somebody with nothing to gain
Not the person selling, and not the person who introduced you. Someone whose income does not change whichever way you decide.
- Test the exit before the entrance
If you go ahead at all, put in a small amount and then take it back out. A scheme that makes withdrawing awkward has told you what you needed to know, cheaply.
- Refuse every deadline
Say you will decide in a week, every single time. The offers you lose by waiting a week are exactly the offers worth losing.
Check yourself
Match each line to what it is really telling you
Show the answer
- "Guaranteed, and far above everything else" → Two claims that cannot both be true
- "You need to decide by Friday" → Pressure designed to stop you checking
- "You earn a share of what you bring in" → The recruits are where the money comes from
- "It's too complicated to explain" → A polite way of ending the conversation
- "Everyone has been paid on time so far" → What a Ponzi does until the inflow slows
Lesson recap
- Ask where the money comes from. If nobody can name the source in plain words, assume there isn't one.
- A Ponzi pays old members from new members' money and pays perfectly on time until the inflow slows.
- Guaranteed and high cannot both be true. Urgency, recruitment pay and unexplainable profits are the other main signs.
- A high rate is not itself a warning where inflation is high. Compare it to the safe, ordinary options around you right now.
- Check the registration yourself, ask someone with nothing to gain, test the exit, and refuse every deadline.