The Spam Diaries

News and musings about the fight against spam.
 by Edward Falk

Friday, March 10, 2006

On 'High Yield Investment Programs' (HYIP)

I know this isn't strictly-speaking about spam, but scams have been much on my mind lately. And besides, HYIPs are sometimes advertised via spam, so that's close enough.

After hearing about the Jennifer Clason case, I spent an hour or so perusing her message board. It was with a sort of sick fascination that I read all the articles by board regulars defending and even promoting the various ponzi schemes and other investment strategies of dubious legitimacy. Even after one such scam was shut down by the SEC, folks were still defending it and wishing the government would just butt out.

So I thought a few words on the subject were in order...

When scientists see someone invent and start marketing a perpetual motion machine, they don't need to examine the machine to know it's a fake; they know without even looking that it's not possible. Of course, they might take a look just to see how the trick was done, but the laws of physics have already told them the truth of the thing.

By the same token, when a mathematician or an economist hears of an investment fund that pays six million percent annual interest (that's what you get when you take the 44% interest over twelve days promised by a typical HYIP and compound it over a year), they don't need to look at the company's financials to know that something isn't right.

In fact, many, if not most, HYIPs are Ponzi schemes of one sort or another. Let's look at how a typical such scheme might work:

Say on day one that one hundred people invest $100 each and expect to earn $12/day for twelve days. Whoever's running the scheme now needs $1200/day in income to pay them off. In a Ponzi scheme, that money comes from new investors, so the people running the scheme will need to recruit 144 new investors to provide that income. But now those 144 new investors need to be paid, so another 208 investors are needed. Some of those 208 will come from the original satisfied customers, reinvesting their money, but some new investors will also be needed.

But those 208 investors will need to be paid off too, so now we need 299 investors for the next round. Then 430, 620, 892, and so on. By the end of the year, you need more than 6,559,000 investors to keep the ball rolling. Eventually the scheme reaches the point where not enough investors can be found and it all comes crashing down. The scheme goes broke, the people operating it have skipped town with a couple suitcases of money, and a whole lot of people are out their hundred dollars. Sometimes the authorities find out and shut things down before too many people get hurt.

The sad thing is, the people investing in the plan really believe in it. Until the crash, it made them a lot of money, and so they really wanted to believe. Quite often, even the people running it believed in it, and can't figure out how it all went wrong. Or they blame the authorities for shutting them down.

Ponzi schemes aren't investment plans, they're gambling plans. You're gambling that you won't be one of the unlucky ones holding the bag when it all goes bad.

Take a moment and think before you join such a program. If there really was a legitimate and safe way to earn six million percent interest on your investment, don't you think Wall Street would have it sewn up? Do you think anybody would even bother investing in conventional things?

Before joining any investment system, find out how the fund actually makes its money. If you can't find any answer other than new investors, then run the other way.

Wikipedia has some excellent explanations of Ponzi schemes and HYIPs. Take a moment and read them.


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