Bernie Madoff and his Ponzi Scheme

The ongoing story with Bernie Madoff and his Ponzi Scheme is another example of financial news that many don’t understand so I thought I would explain a little bit of it for all of you.  Bernie Madoff was a well known, highly successful investor.  In fact, he was the president of NASDAQ stock exchange.  (The NASDAQ is where many technology and technology related stocks are traded)  To put it in terms we can all understand, that position is the financial equivalent of being president of the American Medical Association if you’re a doctor.  (or close to it)  He ran a “Hedge Fund” (we’ll talk about that later) with possibly 50 billion dollars under his management.  That’s twice the value of!

What did he do?  He ran something called a Ponzi Scheme.  Named after Charles Ponzi from the early 1900’s, this is a financial scam that is impossible to get out of once it starts.  Here is the easiest definition.  Investor A gives Mr. Madoff 5 million dollars.  Mr. Madoff tells investor A that in 60 days they should make 20% on their investment.  A few weeks later Investor B signs up and gives Mr. Madoff another 5 million.  60 days is up and investor A is paid not from profits from their investment but from the money that Investor B put in to the fund.  Then, Investor C shows up and the cycle starts again.  This cannot continue forever.  Eventually, it gets too big and payouts can’t be made and it collapses.

What is worse, very little actual money changes hands.  Profits are almost always reinvested in to the fund.  Fraudulent statements were sent out and capital gains taxes were paid on money that investors never really had.  For those who actually did collect real money, they may have to give that money back since it was obtained illegally.  For most, from non-profit organizations to schools to individuals, they probably won’t get their money back.  People all over the world have lost millions and maybe billions at the hands of Mr. Madoff and his Ponzi Scheme.

What does this mean to you?  First, the thing that we don’t hear much about is that Ponzi Schemes work by capitalizing on the ignorance of people.  They don’t know how to invest nor do they know that a 20% return over the course of 30 or 60 days should put up a red flag.  Get rich quick schemes will almost always result in you losing money.  Sound investing based on exhaustive research is how we make money.

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Talk about it:  Should Mr. Madoff be waiting to go to trial in his luxury penthouse?  What motivates people to invest in these types of funds.

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  1. Tim

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