How Does A Ponzi Scheme Make Money

As long as there's been money, there have been folks scheming up ways to steal it.

And throughout history, these folks have been celebrated. Everyone loves an exciting story and nothing is more exciting than a bank robbery!

You have the most famous ones, the bank robbers, and the likes of Bonnie and Clyde, Billy the Kid, Patty Hearst, and many others.

One of the most famous thieves was an airplane hijacker who made off with $200,000 in cash (worth nearly $1.3 million today) in D.B. Cooper. He's never been found.

But the ones that get the most press are the ones who can make off with tremendous sums of money. That only happens when you have people give you the money willingly and over a long period.

The Hall of Fame of fraudsters is littered with those running Ponzi Schemes.

Today, we'll look at how you can run a successful Ponzi Scheme!

What is a Ponzi Scheme?

Charles Ponzi was not the first person to run a Ponzi scheme when he did it in the 1920s. But he was the guy who got the name.

It's really easy to run a Ponzi scheme. You get people to invest in your "fund" by saying you can promise them guaranteed returns of some reasonable annual percentage. You achieve this by putting it in some investment that sounds feasible and somewhat safe to the untrained eye.

Then, you pay out that reasonable percentage each year. Your existing investors earn their money and they're happy. Hopefully, they get other folks to join in. Then, you use the new money to pay out the old money. As long as you get new money from investors, you can pay the existing investors.

The basic idea behind each Ponzi scheme is exactly the same – new investors pay old investors. Old investors are only expecting to see 5-10% of their money back each year, so as long as you can cover that, the rest you can keep as ~~fraudulent~~ gains. Spend it on whatever you like!

Now that you know the basics, here's what the pros know that the novices don't.

You Need an "In"

As you can see, your scheme relies heavily on sales. You need new investors or your house of cards will come crumbling down and you go to jail. Jail is bad.

Your best salespeople will have to lean on existing relationships, kind of like a multi-level marketing scheme. Just as you sell more products when you throw "parties" for your friends (where they buy stuff because they feel like they must), you want to treat your friends to meals, parties, etc. Anything to get them to invest.

Of course, friends are just the first step and most of your friends won't have the funds to invest so you need to expand to other relationships.

Bernie Madoff was successful because he used his relationships in the Jewish community to commit "affinity fraud." Affinity fraud is when a scam targets a group based on race, age, religion, or something the individuals in that group identify with. The fraudster is part of that group, or pretends to be part of that group, and uses the trust within the group to commit the fraud. Madoff targeted wealthy Jews, Jewish organizations, and charitable organizations, including the famed Elie Wiesel's foundation.

One of the first Ponzi schemes in the 1880s, which predated Charles Ponzi himself, was Sarah Howe in the 1880s. Her most famous Ponzi scheme was the Ladies' Deposit Company of Boston, an investment that purported to be a savings bank that only accepted deposits from unmarried women. In her case, the group was unmarried women at a time when it was very difficult to be so.

Make the Returns Believable

The returns have to be attractive but still believable. If you promise 25% returns, no one will believe you. 25% is way too high.

It doesn't matter how good the stock market is doing – no one will believe a 25% return on anything. Even 10% is a little suspicious when online savings accounts are paying 2%. But promise 5% and it's just good enough to be enticing and believable.

The worm has to be juicy enough that your fish will bite but not so juicy that it looks like a lure. Got it?

You also have to dance a delicate balance between high and too high. The higher your interest rate, the more you have to get in new money to pay the old money.

If you promise 10%, then you have 90% left from new money to pay the existing investors. Depending on how large the fund grows, your annual payout increases too. Eventually, what you owe will get pretty big and you need to raise more and more new investors to keep up.

Make the Strategy Believable

Then you have to come up with a good investment strategy for what you're doing with the money to get these returns. This has to have shades of something your investor will understand. If you start talking about cryptocurrencies, it might spook them off because they don't "get" cryptocurrencies. You have to say something people think they understand, even if they don't.

Maybe it's something like you're investing in flipping timeshares. How you have this strategy of buying them on the secondary market for pennies on the dollar and Airbnb'ing them to vacationing foreign tourists who are paying top dollar. This is a bad example because you can't rent out your timeshare, but who would know that?

Each of the pieces sounds right. People understand what a timeshare is. They may even know that they're expensive to buy from the developer (50% of their cost is in marketing), so you're getting a deal buying it on the secondary market! And they also understand renting it out on Airbnb, even if they've never rented one out.

It sounds like the perfect deal!

You just need more money to acquire more timeshares.

Boom. Start printing money.

Here's a real-life example of a plausible investment courtesy of the Mutual Benefits Corporation, owned by Joel Steinger, Leslie Steinger, Steven Steiner, and Peter Lombardi. The company would invest in viaticals, which is when you buy the life insurance policy of an elderly or terminally ill person. The company would pay the premiums and collects the payout when the person dies. They sold $1.25 billion of these policies to tens of thousands of investors… but those policies were fraudulent on many levels. Ultimately, the company used new investments to pay the premiums of old policies and offer a cash return to earlier investors.

Be Famous

Before you can operate a really good Ponzi scheme, you need to build up a brand. You need some fame.

I don't mean TV famous or movie star famous… I mean famous in business. Before Bernie Madoff became a Ponzi schemer, he'd been a pillar in the investment community. At one point he was the Chairman of the NASDAQ! It's easy to sell an investment if your resume has Chairman of the NASDAQ on it.

Robert Allen Stanford, the architect of a $7 billion Ponzi scheme, built up a reputation as a real estate investor. He was even knighted (appointed Knight Commander of the Order of the Nation) in Antigua and Barbuda!

It's easier to sell an investment if you have some pedigree. If you don't have one, make one up!

Some Examples of Ponzi Schemes

When Charles Ponzi did it in 1919, his scam involved pre-paid postal coupons and he promised to double your money in 90 days. The postal coupons part may have been believable but doubling your money in 90 days seems outlandish… except he reportedly brought in $250,000 per day (over $2.7 million in today's money!)

Just two years ago, in 2019, the Woodbridge Group of Companies was revealed as a not-so-elaborate Ponzi scheme promising 5-8% annual returns on 12-18 month notes that were supposedly backed by mortgages.

That's it! There was no flourish to it at all. Wheeee… get 5-8% on these 12-18 month bonds backed by mortgages.

The only area they messed up was in the heavy-handed sales tactics promising it to be risk-free and "crash-proof." Those are HUGE red flags . Nothing is risk-free or crash proof. If they were, everyone would've flooded into it and pushed down the returns.

Want to learn more? This 2001 report from Marquet International titled "The Marquet Report on Ponzi Schemes" goes into great detail on a lot of Ponzi schemes, the characteristics of perpetrators, consequences, and much more. It's a fascinating read and a lot of fun.

If you do decide to run a Ponzi scheme, ask me and I'll be your first investor! Don't ask me if you already have investors!

Thanks!

If it's not clear, this post was 100% tongue in cheek. Don't run a Ponzo scheme. Don't invest in a Ponzi scheme. While I'm sure some Ponzi schemes escape detection (before it can get to a billion, it has to be many millions!) but greed never stays bottled up. You end up going to jail, ruining your life, ruining the lives of your children and those around you.

Think you'll be OK if you invest early? Nope – those fraudulent returns often get clawed back. Don't be stupid. Avoid this!

If you do see an investment that seems a little too good to be true, trust your gut. Invest in the market and you'll do just fine.

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Jim Wang is a thirty-something father of four who is a frequent contributor to Forbes and Vanguard's Blog. He has also been fortunate to have appeared in the New York Times, Baltimore Sun, Entrepreneur, and Marketplace Money.

Jim has a B.S. in Computer Science and Economics from Carnegie Mellon University, an M.S. in Information Technology - Software Engineering from Carnegie Mellon University, as well as a Masters in Business Administration from Johns Hopkins University. His approach to personal finance is that of an engineer, breaking down complex subjects into bite-sized easily understood concepts that you can use in your daily life.

One of his favorite tools (here's my treasure chest of tools,, everything I use) is Personal Capital, which enables him to manage his finances in just 15-minutes each month. They also offer financial planning, such as a Retirement Planning Tool that can tell you if you're on track to retire when you want. It's free.

He is also diversifying his investment portfolio by adding a little bit of real estate. But not rental homes, because he doesn't want a second job, it's diversified small investments in a few commercial properties and farms in Illinois, Louisiana, and California through AcreTrader.

Recently, he's invested in a few pieces of art on Masterworks too.

Opinions expressed here are the author's alone, not those of any bank or financial institution. This content has not been reviewed, approved or otherwise endorsed by any of these entities.