By Tyron Lessing, Certified Financial Planner at Consult by Momentum

As a certified financial planner, I am often faced with questions about new investments that promise high returns with low risk. Examples include so-called ‘exclusive’ high-return funds that promise up to 30% annually and accept investors only by referral. Another example is a crypto token programme that rewards recruits.

Because these conversations are increasingly on the rise, it is important that investors educate themselves about Ponzi schemes and other potentially fraudulent investments, so they know what to look out for.

What is a Ponzi scheme?

The term "Ponzi scheme" is named after Charles Ponzi, who became notorious for running a fraudulent investment scheme in the early 1920s. A Ponzi scheme is defined by a form of fraud where belief in the success of a non-existent enterprise is promoted by the payment of quick returns to the first investors from money invested by later investors.

With time, these schemes have become smart. Very smart. Oftentimes, they have all the makings of a legitimate investment manager – FSP license, knowledgeable staff, great websites and even professional advertising. So how can you tell they aren’t legitimate?

1.         How close is the rate offered to the prime lending rate?

When making a ‘low risk’ investment, you are most likely using a fixed interest instrument such as money market, corporate or credit bonds or government bonds. These instruments aren’t very likely to default; they are generally fairly “liquid” and make for a smooth ride when it comes to returns.

As these funds are typically closely linked to the prime lending rate (10.5%), the first marker to apply when investing in a “low risk, high return” fund is to ask: “Is the rate offered well above the current prime lending rate?”

The importance of this relates to the investment company itself: who exactly are they lending to in order to achieve returns of prime +4, +5 or even +6%? If these businesses were truly stable, they would be more likely to borrow from a bank, where the rate is much closer to prime. A possible answer is that they can’t get more – or any – credit from a traditional institution, hence the need to take on debt at high rates. This, in turn, increases your risk of default.

That’s the best-case scenario: the company is still making a legitimate attempt at securing a “low risk”, high-yield return for their investors  –  however unlikely it is that such returns can be sustained. The worst-case scenario is even more concerning: that the product is completely fraudulent and is using the promise of higher-than-average returns purely to attract new investors.

2.         Are the returns offered realistic – especially in the promised time period?

The same logic can be applied to high return investments. Traditionally, equities or stocks are on the riskier end of the scale, as asset classes likely to make the highest returns over a period of time. However, equities are also synonymous with volatility. When making an equity-based investment, the recommended timeline is anywhere between five to seven years – or more.  

This is mostly due to the probable volatility and provides the investment time to achieve the desired returns. The opposite can be said for a Ponzi scheme-style investment, whereby high returns are promised within a short period of time. How is this possible?

Truth is, it probably isn’t.

3.         Unrealistic expectations

This is, in my opinion, the bigger problem caused by Ponzi schemes, second only to people actually losing their money: “My friend got 25% return in a year, why am I only getting 10%?”

Please don’t get me wrong, there are certainly those investments that can return 25% in a year. But these investments are high risk, ideally longer term, and not guaranteed. Over a 10-year period, they’re more likely to show an annualised return closer to 14% since inception. They are generally not new, “low risk” or with returns “guaranteed”.

The damage related to these is that clients start to lose touch with what is a good and realistic return, and what aligns with their needs and risk profile.

The most common emotional biases that lure in investors are:

• FOMO (fear of missing out): This emotive bias rings true for many situations, as well as investing.  People often see a share or alternative investment that has recently done extremely well and are eager to invest as the fear of missing out takes over. In South Africa, where economic inequality fuels hope for rapid wealth, this emotional pull is particularly strong.
• Desperation and hope: Economic hardship, common in South Africa, can amplify desperation for financial solutions. Scammers prey on this hope, offering “guaranteed” returns to people struggling with debt or unemployment. This emotional vulnerability makes it harder to question unrealistic promises and blurs logical investing principles.
• Confirmation bias: Once invested, you may look for information that confirms the legitimacy of the scheme while ignoring warning signs. Early payouts, a hallmark of Ponzi schemes, reinforce this bias, making you feel the investment is working…until it collapses.

So, what should you do?

Firstly, when looking to make an investment of any kind, ensure that you work with a professional. Aligning your goals, behaviours, needs, your risk tolerance, and timeline are the most important things.

Secondly, do your research: investigate the investment thoroughly. Check if they are registered with the Financial Sector Conduct Authority (FSCA). Do they have a reliable track record? Is their performance far superior to others over time? Can you access your money if needed?

Compare these companies to industry top performers over time. You may very well come across a new alternative investment that is going to outperform traditional investments. However, make sure that regardless of where you intend to invest, that you have done your research, consulted a professional, and only plan to invest a portion of your portfolio. Diversification is still a golden rule in portfolio allocation.

If you are going to take a chance on a new investment, promising great returns despite possible red flags, ask yourself: Am I willing to lose this money? And let that answer guide your decision.