A pyramid scheme is usually pitched as a business opportunity, rather than an investment. The initial recruits to the pyramid-style business model usually get paid, but the main compensation model focuses on recruiting others to the scheme, rather than selling a product. The model falls apart when it can no longer attract new recruits.
In a Ponzi scheme, you're offered an investment opportunity, rather than a business opportunity, and are not asked to recruit others. Instead, the hope is that you'll talk up the huge returns you've been promised, and your friends and family will come to the person running the scheme so they, too, can invest. The scheme collapses if many investors try to cash out at once, or it can't attract new investors.
Why Ponzi schemes matter to investors
It's important for investors to know how to spot red flags in potential investment opportunities. At some point, you may get curious about private investments, which can be risky and are often unregulated. If you pursue them, you risk being taken in by a Ponzi scheme.
Common warning signs of Ponzi schemes include:
- An offer of high rewards with very little risk.
- Overly consistent returns.
- Unregistered investments.
- Unlicensed sellers.
- Secretive or complex strategies.
- Paperwork issues.
- Difficulty receiving payments or cashing out.
But you can protect yourself by sticking with investments that are registered with the SEC, including stocks, bonds, and exchange-traded funds (ETFs). You could also invest in things you can control entirely, like real estate or an art collection.