Charles Ponzi
When you say someone is smart, what comes to mind? Someone with a PhD who went to an Ivy League school? Well, yes you probably do have to be pretty smart in at least one topic to do that. Perhaps you think of a medical doctor, a rocket scientist or a high powered attorney.
Maybe you are not the book type but are street smart? Maybe you think of someone that has a high emotional intelligence (EQ) can read a room, people or a situation before anyone else can pick up on it.
I would say in any of these cases you have an idea of someone who is smart. What do all of the profiles I just mentioned have in common? They all fit the profile of people who have fallen for financial scams.
I asked myself this question after I was lamenting to some highly educated friends the other day about some less educated friends and relatives who have fallen for multi-level marketing or MLM schemes. You know these, you pay money for some product or service that is going to change the world but most of the focus ends up being on getting your friends and family to sign up for it instead. You usually end up losing money, and pissing off a few friends and family members in the process when they too lose money.
It doesn’t necessarily surprise me that people fall for these schemes, especially if they are not trained to be inquisitive or challenge people’s knowledge and expertise. However, a friend of mine had to step in and say no, he knew plenty of people including his own dad, who has flown all around the world as an airline pilot, would still get sucked into these different scams to make money.
When I thought about it, he did have a good point. I have a few friends that are medical doctors that are always asking me how to invest or where to put their money. Within 5 minutes of talking to some of them, I can tell they haven’t the slightest clue of the bare basics of investing so I have to back pedal my explanations and get as basic as I can to help guide them through. In fact, medical doctors are some of the most preyed upon when it comes to financial scams.
We can’t just pick on doctors though, as the Bernie Madoff scandal showed us, even the most highly sophisticated investors can be duped. The man who sniffed Madoff out and reported him to the SEC in vain, Harry Markopolos, had to statistically determine and prove that Madoff’s returns were impossible to be duplicated in the known investment universe to prove he must be lying. When you have to be a mathematician to prove someone is a scammer, the scam must be pretty good.
So why is it that so many folks, even the so called smart ones, fall for these scam?
Overconfidence
The first reason according to my research is overconfidence. When you are an expert in a field, your day to day may be dominated by a field where you are a world class expert. Over time this may give you a pumped up sense of self esteem and you may start thinking if you are good at what you do all day, you can be just as good at other things.
We tend to overestimate our abilities in many areas though and just because you can fly a complex machine thousands of miles or replace a beating heart, amazing feats in themselves, it doesn’t mean you necessarily know the inner workings of the Black-Scholes option pricing model.
FOMO
FOMO or the fear of missing out is a big psychological factor that encompasses a range of different issues from greed, to envy to the assumption that the “experts” know something we don’t. As I showcased in my recent post on Bitcoin, this mentality contributes again and again to asset bubbles where common sense seems to just go out the window in favor of greed.
Just like lemmings headed off a cliff however, there is no happy ending to this party. The scammer may create a sense of urgency, like having a limited time offer or they may brush off your doubts or questions in a way that says “suit yourself, me and the rest of us will get rich without you.”
This points to another area where they can make you feel excluded, that they have a secret you don’t. I recall being a young analyst and hearing some other analysts discussing the market. They each went around and contributed their piece as to where they thought things were going. One analyst in particular struck me, when talking about Google stock he said something along the line of “you’ll see it steadily creep up to the $600 mark within the next few weeks, once it breaches that, it will drop back down another $10-$15.” He sounded so sure about it, I wondered just how he knew?
In retrospect it was complete garbage, no one knows what the market is going to do the next day or the next week and anyone who tells you they do is a bold faced liar. It was his confidence that was so convincing though, he created the sense that he had some knowledge that others didn’t have. You give a financial advisor this type of confidence and some unsophisticated investors and he or she can sell them the world.
Source: wikihow.com
Social Pressure
This is where the MLM comes in. In a vaccine many of us would be able to pick apart the tell tale signs of a potential scam: the too good to be true story, the get rich quick fantasy, the sense that it’s so easy that anyone can do it.
However our minds can get confused when this story is coming from someone we trust or love. Just by having an established relationship they already have broken down a number of psychological barriers with you so you are already a little vulnerable to their suggestions. A friend or family member who comes to you with a proposition is essentially staking their reputation or status with us on it, so their is a history which doesn’t need to be built already to have a high level of trust.
Of course, this person may not even know the are scamming you because they are being scammed themselves. They are totally convinced of the scam and when it eventually becomes apparent relationships and friendships can be severely strained.
How Do They Keep Getting Away With It? My Own Brief Experience
When I was initially introduced to a MLM scheme I went straight to work and did my research. I knew something had to be fishy when I sat through a two hour presentation and I couldn’t understand how they still made money, but hey, the drinks were free and the woman who invited me was beautiful so I endured it. If I have a degree in math and a master’s in finance and I still can’t figure out from the power point how they make money, then something must be wrong.
I dived into a number of forums where former adherents complained of being ripped off. All of them seemed to complain about one woman who was one of the regional directors. My friend who brought me to the MLM event mentioned this director had a beautiful apartment in midtown Manhattan with a grand piano in it and all just like the movies.
When I did my research on this woman, I came across a potential bombshell in one of the forums. One person claimed the husband of this woman had a legitimate job and was the real money maker. However the wife used the MLM scheme to claim the losses of those she signed up as her own and offset her husbands income with the loss. If true, I have to admit, it’s a pretty evenly genius way to avoid taxes and probably not even legal.
The company whose presentation I watched was investigated as recently as 2017 for being a Ponzi scheme but it seems they just aren’t Ponzi enough for it to be illegal, although I did find that the founders had previously pleaded guilty to securities fraud.
Ethics Is Key
In short, there is no substitute for ethics and honesty. If you are introduced to a money making idea, seek the help of a trusted expert. These aren’t always easy to find, a good start would be to look for a financial advisor who is a fiduciary advisor. This means they are sworn (upon a bible?) to put their clients interest first.
According to CNBC, one in five financial advisors commit fraud with intent or lying. Taking the time via reference and prodding questions to a potential financial advisor will pay off in the long run and steer you clear from the get rich quick and Ponzi schemes out there waiting to get the best of us.
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