Avoiding scams and illegal schemes

You will very quickly learn that there are factors common to all investment scams:

they don't have a product disclosure document
they promise high returns
the investments are often based overseas or must be kept a 'secret', presumably so other people don't find out about the offer and make a killing as well.

Ponzi schemes

The simplest, yet most effective scams perpetrated on unsuspecting investors for many years have been Ponzi schemes. The scheme only requires a few victims in its early stages to be successful. The promoter promises you a very high return on your investment and says it is secure.

Part of the money deposited by early investors, is then used to pay their first dividend cheques or interest. The victims are more than happy to get high dividends. The swindler continues paying them dividends for a couple of months until they are more comfortable with their investments, and decide to invest more. They then begin to urge their friends and relatives to invest as well. Soon, there is a steady flow of funds into the scheme, and the number of investors grows.

Provided the swindler is disciplined about how much money is left in the account to pay 'dividends', the scam can go on for many years. Theoretically, if the scheme continues to draw in new investors, it could go on indefinitely. In practice they usually fall over because the promoter starts to spend the money too quickly, or the pool of investors starts to dry up.

More about Ponzi schemes

International bond schemes

Australian investors have lost millions of dollars in fraudulent schemes promoted with names such as 'international bonds', or 'prime bank instruments' which offer very high returns. Many of these schemes expand their network by asking you to tell your family and close friends about the scheme.

Pyramid investment schemes

These schemes operate in a similar way to pyramid selling schemes. One person 'invests' some money in the scheme. The only way they can move up the scheme is if they introduce other people to 'invest' in the scheme. There is never any real product into which the money is invested; all that happens is that the money flows up the pyramid.

Theoretically, the scheme will go on forever, and everyone who joins in will make money out of it, but in practice the only way for new investors to profit is if there are new recruits. Each new investor will find it more of a struggle get new people to join the scheme and to make money. In Australia it is illegal to promote or participate in a pyramid investment scheme.

More about pyramid schemes

Nigerian letter scams

Letters are sent from a person claiming to represent a government agency in Nigeria. The letter asks you to give your bank account details so they can use your bank account to get many millions of dollars offshore - for which you will be paid a generous commission. Ignore these letters and do not give the scamsters any bank details. All that happens is that they withdraw the balance out of your account. At least six people who provided their account details traveled to Nigeria to investigate the scheme and were murdered.

3 tips on how to avoid scams

1 Find out how the investment works
Always take time to think about a proposal and make sure you know how it works. If you don't understand the information you are given, take it to an accountant or licensed adviser to discuss with them.

2 Always ask for the prospectus or product disclosure statement (PDS)
A prospectus or PDS will set out all the information you need to make an informed decision about an investment scheme. It will give you information about the financial position of the company or scheme and its future prospects.

Even small investment schemes need a prospectus
Guide to reading prospectuses
What's a product disclosure statement?

3 Beware of investments offering high returns with 'no risk'
They are usually the worst risk of all. A high return is as little as 2% higher than the return offered by established companies offering similar types of products. Higher returns mean a higher risk that you may lose money.

More information

FIDO Website: Printed 09/06/2010