You can’t check the news today without reading about the sentencing of Bernard Madoff, who received 150 years for operating his multi-billion dollar Ponzi scheme.
Madoff jailed 150 years for ‘massive’ fraud (Globe and Mail)
Madoff gets 150 years for fraud (CBC)
What is a Ponzi scheme, and how can you recognize and avoid it?
The Ponzi scheme was named for Charles Ponzi, a clerk in Boston who first devised such a scam in the early 20th century.
To best understand a Ponzi scheme, think of the chain letters that were all the rage in junior high school – when people still used snail mail. If you sent a letter to six friends, who sent a letter to another six friends and everyone also sent two postcards, then all participants were supposed to receive 36 post cards from exotic locations all over the world. How many of you sent the letter? (Don’t be shy, we’ve all done it.) Now how many of you actually received 36 postcards?
Ponzi schemes are run in a similar fashion. Typically, investors are recruited through promises of high returns. Early investors often receive returns fairly quickly from “interest cheques.” They may be so pleased with their returns that they re-invest, or recruit friends and family as new investors.
Here’s the catch: The investment doesn’t exist. The “interest cheques” are paid from investors’ own money and the contributions of new investors. The scheme eventually collapses when the number of new investors drops.
Just as with the chain letter, where you may have received a few postcards before things petered out, with a Ponzi scheme, you may receive some returns, perhaps even for years, before new investors run out and the money dries up. Then you discover you weren’t receiving “interest” after all, and your initial investment is gone.
Of course, all you ever invested in your chain letter (I hope) was your time and your hopes. And the cost of a few stamps. Sadly, many have lost much, much more to Madoff and other scammers.
Can you indentify the Red Flags in the Ponzi description? Learn more about how to spot a fraud.
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It’s been a bleak year on the markets, and that appears to be taking its toll on investors’ relationships with their advisers. Canadian investors are showing their dissatisfaction by withholding recommendations to friends and family members.
Twenty-four per cent of investors participating in a recent J.D. Power and Associates survey said they would “definitely” recommend their primary investment firm, down eight per cent from the year before. Ten per cent of investors said they were considering switching advisers this year, compared to six per cent in 2008. (Read more in the Globe and Mail.)
Are advisers taking too much of the blame for the market downturn? While some advisers who get the boot may well deserve it, it is worth considering whether Canadian investors have realistic expectations.
Think of your relationship with your adviser as a partnership, with both of you working to achieve your financial goals. You are both responsible for making this work. And like any relationship, open and honest communication is key.
What you should expect from your adviser
The role of your adviser is to give you helpful, informed advice as you build and carry out your plan. Your adviser is obligated to act in your best interests at all times and to recommend investments that are suitable for you.
To do this, your adviser will need to take the time to get to know you and get a clear understanding of your financial situation, your goals and how you feel about risk.
Once your plan is in place, your adviser should tell you about investment opportunities, as well as any changes that could affect your investments. Your adviser should be available to answer your questions, especially during market lows when you may be tempted to act on your emotions.
You can expect your adviser to:
- make clear and specific recommendations
- explain the reasons for the recommendations
- point out the strengths and weaknesses
- outline the risks involved
Your adviser must get your permission before they take action like buying or selling investments for you, or withdrawing money from your account. The only exceptions are if you have given your adviser “discretionary” authority or you have given someone else trading authority or power of attorney over your account. Your adviser will send you a written confirmation of any transactions they make for you and will send you regular account statements.
What you should not expect from your adviser
Your adviser will not be able to:
- predict the performance of the markets with certainty
- recommend investments that are always profitable
- act on vague or general instructions to buy or sell investments
- meet unrealistic goals or expectations of profit
For more tips on working with an investment adviser, read the CSA’s Working with a financial adviser brochure.
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