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As defined by Dictionary.com, a Ponzi scheme is “an investment operation that pays quick returns to initial contributors using money from subsequent contributors rather than profit”. In other words, once new money stops coming in, the party ends! Believe it or not, the United States Social Security system is essentially a Ponzi scheme because current contributions are used to pay current distributions.....
If Social Security doesn't collect enough contributions, then the distributions can’t continue. Per definition, that is a Ponzi scheme.
Many of us are aware of Bernard Madoff who ran the most infamous Ponzi scheme of all time. He promised unrealistic returns by using money from new investors to pay out those returns. When the Great Recession hit in the mid 2000’s, investors didn't have money to continue contributing to his investments. No new investments meant there was no money to payout “returns”. Game over!
While most of us know of Madoff’s Ponzi scheme, we probably don’t realize we know several people running their own Ponzi scheme. In fact, you may be running one yourself without knowing it! I’ll explain further by sharing a story I heard in a financial class for which I was volunteering.
A gentleman in this class shared his collection of 72 credit cards. Yes, 72!
What started with an innocent 0% interest card and some balance transfer offers, ended with a stack of plastic. This gentleman would max out a credit card and then transfer that balance to a new card with a 0% offer. When that 0% offer ended, he would transfer that balance to another new card with the same 0% offer. This allowed him to re-charge the previous cards since their balances were zero after being transferred. He essentially repeated the same behavior until the credit card offers eventually stopped. Once the “new money” quit coming in, the previous money owed couldn't be transferred; and you guessed it, he didn't have the money to just pay the balances off. That was the end of that credit card Ponzi scheme!
The best part was that the whole time he shared this story there was a gleaming smile on his face. The smile was because he had cancelled and paid off every one of those credit cards. He was free from his Ponzi scheme, and didn't have to go to jail for it because he paid the price legally!
There is no reason to be ashamed, regardless of how embarrassing you think your situation is. The key is to come clean and admit your mistakes. Then work hard to fix your mistakes the right way. We created a personal finance coaching system to help you. Click here for more information.
Do you know anybody running a Ponzi scheme? Share your comments below.
Extra Tidbit: Charles Ponzi was the original organizer of this scheme in 1919. He died in 1949.