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Investing 101: What is a Ponzi scheme?

Andy Samuels' photo
Business and Finance 101 Examiner

Bernie Madoff (AP Photo/David Karp)

Recently made popular by Bernie Madoff’s 50 billion dollar fraud, the term Ponzi scheme derives its name from the Bernie Madoff of the early 1900’s, Mr. Charles Ponzi.

A Ponzi scheme is a type of pyramid scheme where investors are enticed to invest by unusually steady or unusually high returns. Once hooked, the new investors’ money is used to pay off older investors at the “too good to be true” rates that originally lured them into the scheme.

The scheme is dependent upon a steady flow of cash from an ever increasing number of investors (the true source of income for the scheme), and because of this, Ponzi schemes are unsustainable by nature. 

 
Here's a quick video explaining how a ponzi scheme works.

 

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, Business and Finance 101 Examiner

Andy Samuels is an Examiner.com intern and Cherry Creek High School (Denver) student who's won a state award for his opinion writing on business and financial matters. He is the Editor-in-Chief of his high school paper which recently won first place for the 5A division of high school newspapers...

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