When investing, your capital is at risk and you may get back less than invested. Past performance doesn’t guarantee future results.
Types of investment scams and how to avoid them
While many focus on maximising investment returns, the world’s wealthiest individuals often recommend asset protection as the first step toward financial well-being. Part of that protection must be against investment scams.
QUOTE
It's not how much money you make, but how much money you keep, how hard it works for you, and how many generations you keep it for.
Big ideas
- Investment scams can be hard to spot if you’re not watching carefully; but there are always signs. The promise of high returns from some kind of exclusive, time-restricted offer is usually the basis on which a scam is built.
- The most common investment scams are Ponzi schemes, Pyramid schemes, and Pump and Dumps schemes. However, there are a variety of other attack vectors to conduct financial fraud.
- Sadly, the number of investment scams is on the rise and the cryptocurrency industry is particularly susceptible, with little regulation, little oversight, and significant investment interest.
How do investment scams work?
Investment scams entice individuals into parting with their funds to invest in an opportunity that doesn’t exist, promising rewards that never materialise.
Not only have investment scams been on the rise in recent years, but they have also become increasingly sophisticated.
Not only have investment scams been on the rise in recent years, but they have also become increasingly sophisticated.
Source: Financial Times (2023)Modern technology exacerbates the problem. With the power of AI in terms of quick website generation, photo editing, and document forging (not to mention deep fake video AI) the prospect of being scammed can seem quite daunting.
But there is nothing to fear for those who take the time to investigate an offer being presented to them and refuse to allow their emotions to overpower them. Remember, uncontrolled emotions are the real enemy of every serious investor, even without a scam!
The reality is that investment scams are changing in form, but they are not changing in essence. They all rely primarily on greed, fear of missing out (FOMO), and a lack of due diligence on the part of the victim.
But there is nothing to fear for those who take the time to investigate an offer being presented to them and refuse to allow their emotions to overpower them. Remember, uncontrolled emotions are the real enemy of every serious investor, even without a scam!
The reality is that investment scams are changing in form, but they are not changing in essence. They all rely primarily on greed, fear of missing out (FOMO), and a lack of due diligence on the part of the victim.
Four key signs of investment fraud
Investment scams can seem to be very complex and convoluted in terms of how they work. There are an infinite number of ways a scam can take place. Yet there are four key traits common in the vast majority of scams. The four major signs to look out for are:
- High returns with little risk.
- Limited time to act/exclusive offer.
- Lack of transparency for founding team identity, company origins, etc.
- Lack of registration with relevant authorities.
Higher returns and an exclusive offer in a limited window are nearly always present in investment fraud, playing on base human emotions - and the temptation of a quick buck. The lack of transparency and registration can be manufactured with some kind of decoy to build apparent credibility in the eyes of the would-be investor in the scam scheme.
Building trust through deceptive practices
In all scams, trust has to be established. Some social engineers will often wait for months just establishing trust, before asking for any funds. Moreover, registration or identity documents can be easily forged using online tools. It is also very easy to quickly create a phishing website that mimics a legitimate site and steals usernames and passwords.
Source: Internet Crime Complaint Center (IC3)In the cryptocurrency industry, scam ICO presales will often have a third-party smart contract audit that indicates that the code has no serious flaws or errors. This is a ubiquitous yet mostly meaningless audit that gives the project a veneer of legitimacy.
The overwhelming majority of such ICO coins go close to zero within a short space of time. The audit is a decoy for projects that often have no real registration and no publicly viewable founders. If they are registered, it will often be a shell company in a location such as the Cayman Islands or the Bahamas.
The overwhelming majority of such ICO coins go close to zero within a short space of time. The audit is a decoy for projects that often have no real registration and no publicly viewable founders. If they are registered, it will often be a shell company in a location such as the Cayman Islands or the Bahamas.
Psychological manipulation techniques
There are a large number of psychological manipulation techniques that can be used to entice an investor to part with his/her funds. Again, it has to be stated that these are only different techniques for the same manipulation. Greed and FOMO are exploited, with some trust-establishing strategies.
Investors want to believe that large returns can be achieved with limited risk. So these returns are emphasised, with an urge to action to avoid missing out. Combined with a few strategies to build trust, many investors end up falling for the scam, when a quick online search would have allowed them to keep their funds.
Scammers will also be aggressive in their sales/marketing, or could alternatively impersonate a person of authority. They could, for instance, send an email impersonating a government official, accusing an individual of financial fraud, urging them to quickly send sensitive details.
Investors want to believe that large returns can be achieved with limited risk. So these returns are emphasised, with an urge to action to avoid missing out. Combined with a few strategies to build trust, many investors end up falling for the scam, when a quick online search would have allowed them to keep their funds.
Scammers will also be aggressive in their sales/marketing, or could alternatively impersonate a person of authority. They could, for instance, send an email impersonating a government official, accusing an individual of financial fraud, urging them to quickly send sensitive details.
Major types of investment scams
Investment scams often promise high returns with little risk, but spotting their red flags can save you from financial loss. Understanding how schemes like Ponzi, pyramid, or crypto fraud work helps you avoid falling victim.
Pyramid schemes
DEFINITION & EXAMPLE
Pyramid schemes rely on recruiting new members to generate returns from member fees/charges, rather than selling the product/service in question. New recruits make payments to those above them in the hierarchy, creating a structure where money flows upward. Participants are incentivised to recruit others, often with the promise of high returns based on recruitment success.
In the 1980s, an aeroplane game became popular, where participants paid a ~£1,100 entry fee for a chance to receive an ~£8,000 payout. The structure resembled an aeroplane, with eight new recruits on the bottom "engine level".
Each recruit moved closer to the "pilot seat", where they would supposedly have received their payout. However, as recruitment slowed, the scheme collapsed, leaving most participants with losses as new funds dried up and payouts could no longer be sustained.
In the 1980s, an aeroplane game became popular, where participants paid a ~£1,100 entry fee for a chance to receive an ~£8,000 payout. The structure resembled an aeroplane, with eight new recruits on the bottom "engine level".
Each recruit moved closer to the "pilot seat", where they would supposedly have received their payout. However, as recruitment slowed, the scheme collapsed, leaving most participants with losses as new funds dried up and payouts could no longer be sustained.
With each level, more participants are required to sustain the payouts to earlier members. Eventually, as recruitment slows, payouts become impossible to sustain, and the scheme collapses.
Pyramid schemes are often structured to appear legitimate, but their reliance on recruitment rather than genuine economic activity ultimately leads to failure.
Pyramid schemes are often structured to appear legitimate, but their reliance on recruitment rather than genuine economic activity ultimately leads to failure.
DEFINITION
A multi-level marketing (MLM) scheme has characteristics of a pyramid scheme but is considered a legitimate business model.
The key difference is that MLM revolves around an actual product or service, whereas a pyramid scheme focuses solely on recruiting new members until it inevitably collapses.
However, it is often argued that some companies present themselves as MLMs with a product, but the product merely serves as a facade, while the primary focus remains on selling memberships, licences, or similar offerings.
The key difference is that MLM revolves around an actual product or service, whereas a pyramid scheme focuses solely on recruiting new members until it inevitably collapses.
However, it is often argued that some companies present themselves as MLMs with a product, but the product merely serves as a facade, while the primary focus remains on selling memberships, licences, or similar offerings.
There are some exceptions to this. It is possible for a large Pyramid or Ponzi scheme to have registration and a known owner identity. In this instance, the best strategy is simply to get familiar with these common kinds of scams, so you can quickly identify them.
Pump and dump schemes
DEFINITION & EXAMPLE
A pump-and-dump scheme involves buying then artificially inflating the price of a stock or asset to attract new buyers then quickly selling it.
Promoters spread positive but misleading or false information to create excitement around the asset. This pump phase encourages increased buying activity, driving up the price. Once the price is sufficiently high, the promoters sell their stock and stop the good news, creating selling pressure that causes the stock to dump back to or below the price it started.
During the late 1990s tech boom, promoters inflated the stock prices of small, internet-based companies by spreading hype, with prices often jumping from under £1 to £10 or more within days. Investors, seeing the quick gains, rushed to buy in, driving the stock higher.
Once prices peaked, promoters sold their shares at an inflated value. For example, a £1 stock could be sold off for £15 or more, leaving new investors holding shares that soon dropped back to pennies. This led to sharp financial losses for late entrants.
Promoters spread positive but misleading or false information to create excitement around the asset. This pump phase encourages increased buying activity, driving up the price. Once the price is sufficiently high, the promoters sell their stock and stop the good news, creating selling pressure that causes the stock to dump back to or below the price it started.
During the late 1990s tech boom, promoters inflated the stock prices of small, internet-based companies by spreading hype, with prices often jumping from under £1 to £10 or more within days. Investors, seeing the quick gains, rushed to buy in, driving the stock higher.
Once prices peaked, promoters sold their shares at an inflated value. For example, a £1 stock could be sold off for £15 or more, leaving new investors holding shares that soon dropped back to pennies. This led to sharp financial losses for late entrants.
As the price drops, unsuspecting investors are left with losses. Pump and dump schemes are often short-lived and target assets with low trading volume, which are easier to manipulate.
Alternative scams to avoid
Scams can also be classified according to their main area of operation, such as crypto investment scams, romance scams, investment training scams, and precious metal scams.
- Crypto investment scams - there are many scam variants involving crypto transfers. Crypto presale scams often promise huge returns but have no public team or registration with a verified body. Teams can also pump and dump coins or engage in a rug pull - changing the code to confiscate all deposits.
- Romance scams - dating apps can be used to prey on individuals seeking attention, enticing them to send funds for one reason or another. People who are already vulnerable due to depression or loneliness are more likely to fall prey to romance scams.
- Investment training scams - the internet is riddled with training materials on how to become the best trader, or how to use an automated income model. There is, of course, no automated or easy way to earn wealth. There are no proven or patented investment models. If it was truly automated and bulletproof, the creator would simply use it to create near-infinite wealth.
- Precious metal scams - for more than 50 years (since the USD was unlinked from gold in 1971), people have been claiming monetary collapse and a gold explosion of 10x or more. Precious metals have always been a strong hedge, yet stocks have always outperformed. These are not exactly scams, but dealers will typically create a false sense of urgency to get people to invest.
Scams can of course be combined in a variety of ways, and fraudsters can be extremely creative. Elderly individuals are particularly vulnerable, not having sufficient knowledge of modern technology and how it can be used for nefarious purposes.
How to spot and avoid investment scams
The somewhat tragic fact is that investment scams are usually quite easy to avoid. In many instances, all it takes is a quick search of a database, such as the Companies House in the UK, to check for official registration.
If a project is promising:
If a project is promising:
- High returns with limited risk
- Time-restricted
- No registration or founder information
it should set off immediate alarm bells in your head because it is almost certain to be an investment scam.
Checklist - how to check if an investment is a scam
To reiterate the above, even one of the following items in the checklist is a cause for concern to be investigated. When being presented with an investment opportunity, particularly from a stranger but even from somebody you know, always ask yourself:
- Does the investment offer high returns with limited risk?
- Does the investment present a time-restricted opportunity?
- Are the founders publicly viewable?
- Is the company registered with a reputable authority?
Aside from these four major red flags, scam investment opportunities might have strange payment methods, only accepting gift cards, Western Union, cryptocurrency, etc. There is also likely to be a lack of transparency in terms of the investment details and how funds can be redeemed.
Recap
While scam artists have been very creative and the power of modern technology can be used to create some very elaborate heists, the reality is that investment scams have not changed all that much over the years.
They rely on FOMO and greed, promising high returns and exclusivity, with pushy sales and tactics of urgency. These are the main ingredients, combined with a few (typically see-through) mechanisms of trust-building.
The fact is that the majority of defrauded individuals did not complete even rudimentary due diligence, which would have quickly revealed the true nature of the campaign.
Two rules of thumb when investing:
They rely on FOMO and greed, promising high returns and exclusivity, with pushy sales and tactics of urgency. These are the main ingredients, combined with a few (typically see-through) mechanisms of trust-building.
The fact is that the majority of defrauded individuals did not complete even rudimentary due diligence, which would have quickly revealed the true nature of the campaign.
Two rules of thumb when investing:
- Only take financial advice from somebody you have actually met in person.
- If it seems too good to be true, it almost certainly is.
For more common scam scenarios and tips on how to avoid them, check out our guide on protecting yourself from fraud.
This article is for informational purposes only and does not constitute financial, investment or legal advice.
This article is for informational purposes only and does not constitute financial, investment or legal advice.
FAQ
Q: What are common investment scams?
Common investment scams include Ponzi schemes, where returns are paid from new investors’ funds; pyramid schemes, which rely on recruiting new members for profits; and pump and dump schemes, which involve artificially inflating stock prices before selling at a peak. Other types include fake initial coin offerings in crypto markets and too good to be true investment opportunities in low-regulation environments.
Q: Why do people fall for investment scams?
People often fall for scams because of promises of high returns with little risk, which can appeal even to seasoned investors. Scammers use sophisticated tactics, like creating fake portfolios, or they display selective results that look legitimate. Investors may be drawn in by the appearance of exclusivity or fear of missing out, which can override scepticism.
Q: Who is most at risk of being scammed?
Those most at risk are often newer investors unfamiliar with certain markets or products, like cryptocurrencies or private equities. Elderly individuals, who may lack tech experience, are also common targets. However, even experienced investors can fall for scams that appear highly credible, particularly those promising above-average returns from seemingly reputable sources.
Q: Do banks refund scammed money?
Banks typically do not refund money lost to investment scams, especially if the scam involves transferring funds willingly to fraudsters. Some banks may investigate if fraud is detected early, but they often disclaim responsibility in cases where investors authorise transfers. Refunds are rare, as banks see the decision to invest as the customer’s risk, not a banking error.
Q: How do you outsmart a money scammer?
Outsmarting scammers involves recognising common warning signs in investment offers. Scammers may use high-pressure tactics or promise guaranteed returns. Being sceptical of unsolicited offers, especially those that target emotions, helps. Simple checks on companies’ legitimacy, or basic research on investment terms, can reveal inconsistencies in fraudulent schemes. Recognising red flags early is key to avoiding traps.
