Good Question - What Is A Ponzi Scheme?

By: Jeff Herndon Email
By: Jeff Herndon Email

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You may have heard the name Bernard Madoff in the news lately. He's the guy who was arrested for allegedly running the biggest Ponzi scheme in history.

What exactly is a Ponzi scheme? Good question.

The term "Ponzi scheme" was named after a guy named Charles Ponzi, an Italian emigrant. Although he didn't invent the technique, an operation of his in the early 1900s took so much money, it was the first to become known in the United States.

A simple way to explain the Ponzi scheme using pennies:

Jeff approaches Ben, telling him he will invest his penny and double his money in ten minutes. Ben invests.

Jeff then approaches Scott, offering him the same line of doubling his investment.

After taking Scott's penny, Jeff then takes the two pennies, and shows the "doubled investment" to Ben. Ben is impressed and invests more money.

Jeff then uses the money from Ben to convince Scott to invest further.

If either Ben or Scott were to ask Jeff how their money keeps doubling, Jeff would give them vague answers and use terms like "global currency", "hedge funds" and "offshore investments".

It doesn't take long for Ben and Scott to tell their friends about Jeff's amazing returns. Then, it's easy. The money is never invested. Jeff is simply using other investors' money to pay fictional and unrealistic returns.

This is what Madoff is accused of doing, but not with pennies, with $50 billion.

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