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© Copyright 1997, Jim Loy
I would like to invite you to invest in my new company, Money Unlimited. The stock sells for $100 a share. And I guarantee that you will double your money in six months. What do we do at Money Unlimited? We do lots of things. One thing we do is invest your money, much as a bank does. We also do foreign currency trading. Just watch what has happened in the last few months:
Month #1: We sold 1000 shares, at $100 a share. That was $100,000 in the bank. And the money began to work for the investors, as you will see shortly.
Month #2: We sold 1000 shares. And we earned $2000 from our various invenstments. That was $202,000 in the bank. As the number of investors increased, our profits increased substantially, as you will see shortly.
Month #3: We sold another 1000 shares. And we earned $4040 this month. Cash in the bank, $306,040, looking good.
Month #4: Sold 1000 shares, earned $6120, in bank $412,160.
Month #5: Sold 1000, earned $8240, in bank $520,400.
Month #6: This month we paid our original investors. We paid off all 1000 shares at $200 per share (offering a variety of deals would have just complicate this article). Then many of these satisfied investors bought back one or more shares. So we had our biggest month ever, selling 2000 shares. We earned $10,400, paid $200,000 in dividends, and had $530,800 in the bank afterwards.
Month #7: Word has gotten out that Money Unlimited is a great investment. We sold a record 4000 shares. We earned $10,620, paid $200,000 in dividends, and had $741,420 in the bank.
Month #8: We passed a million dollars! Sold 5000 shares, earned $14,830, paid $200,000 in dividends, and had $1,056,250 in the bank!
That's how Money Unlimited stands, right now. Things are looking great. We could use a smart investor, like you.
Did you notice anything fishy in the above? Well, the first clue is that we are paying out 200% every six months (400% per year). But we are only earning about 24% per year. Should that scare you?
So, why do we keep making money? The answer to that question is: We aren't making money. We are losing money big time.
We don't need to use higher mathematics, or even advanced economics. Simple accounting practices involve assets and liabilities. After one month, we had $100,000 in the bank. Is that profit? No.
| assets | $100,000 |
| liabilities | -$100,000 |
| total | $0 |
If these people want their money back, right now, we owe them $100,000 (as their investment has not matured to $200,000 yet). So our profit was zero.
But a more realistic (and honest) way to look at it is to pro-rate the $200 per share that we will have to pay after six months. So, instead of owing our investors $100 per share, and then $200 at the end of six months, we owe them the original $100, plus about $17 for each month.
| assets | $100,000 |
| liabilities | -$117,000 |
| total | -$17,000 |
So, Money Unlimited actually lost about $17,000 the first month. I can't buy a new car, just yet. I almost bought the car, as I had $100,000 in the bank.
The next month, we lost about $34,000 in the same way. But, we earned $2000 on our investments. So our actual loss was about $32,000. Darn, I was going to buy a second car, and one for each of my neighbors.
We lost more and more every month, because we always owed more than we had. After eight months, we had over a million dollars in the bank. But we owed almost two million.
We keep getting more and more money, as long as people keep investing. Once we run out of investors, we lose. And we go to jail, for fraud.
Quite a few investors actually made money, AND GOT OUT. Many of them probably even realized what was going on. They played a risky game, and won. The rest of the investors lose.
This scam is called a Ponzi Scheme, or a Pyramid Scheme. It involves taking money from your new investors, and giving it to your old investors. It works if you keep gaining more and more new investors. You eventually run out of investors. If everyone on earth invested all of their money, you would eventually (not very long, actually) run out of investors.
So, I'm going to end up in jail. And your money will end up in Switzerland. Want to invest?
P.S. So, is every investment opportunity that goes belly-up a Ponzi Scheme? Probably not. But, I'm beginning to think so.
Comments: I disguised my Ponzi Scheme, by telling you that I was investing your money, and doing foreign currency trading. This was a lie. I could have invested your money, but why bother? The amount of money that I could make would be trivial, compared to the money I make with my scam. In the end, the prosecutor will discover this lie, and then I will be sorry that I didn't invest your money.
One thing that Pyramid Schemes often involve is a reward for bringing in new investors. In fact, this may be the only reward, instead of the "double your money" that I promised. The situation is similar to my scam. It still collapses, when you run out of new investors.
The people who made money, and got out, may be in some trouble. The courts may seize their profits, and redistribute them among the victims. This may be unlikely. But, it is a further risk.
Some such scams may not even pay back any money. The con artists may just take the initial investors' money and run. This is not technically a Ponzi (or Pyramid) scheme, but simple fraud. In my scam, the reluctant investors got involved, once they saw that investors were being paid off. And the old investors probably reinvested, maybe even borrowing money to do this.
Further comments: Maybe I won't go to jail, just yet. There is actually a very popular way to avoid jail in the above scheme: pay back all of the money to the investors, plus a little profit. Where does that money come from? From a bigger pyramid scheme. This one's a little slower, but you need $10,000 minimum to invest in it. Interested?
Another popular dodge is to skip the country. After all, I've got money.