Investment Fraud and How to Avoid It

By Barbara O’Neill, Ph.D., CFP®, Rutgers Cooperative Extension, boneill@njaes.rutgers.edu

Each year, thousands of consumers lose billions of dollars to investment fraud. Con artists use chat rooms and social media to post “urgent” messages telling people to buy a particular stock. They also use telephones to take advantage of unsuspecting victims. The movies Boiler Room and The Wolf of Wall Street provide valuable insights into how unscrupulous operators steal victims’ money by peddling worthless or nonexistent securities.

Man in front of laptop
IAmMrRob/Pixabay.com, CC0

So how do you know if an investment is fraudulent? Below are five red flags:

  1. Future Predictions– Beware of marketers that guarantee an investment’s future return. With the exception of bonds, investment returns are unpredictable and the value of securities rises and falls with market trends.
  2. Quick Cash– Scam artists often promise fast, low-risk payoffs and compare their returns to low rates available on bank accounts or bonds. Their implication is that victims are “suckers” for settling for low returns and that they have a sure path to high returns in a short period of time.
  3. Obscure Origins– Background information about the origin and performance of fraudulent investments is misleading or not provided because marketers do not want consumers to be able to assess their claims.
  4. Immediate Response– Requiring an immediate response and deposit of funds is another hallmark of investment fraud. Urgency is important to swindlers so they get victims’ money fast before victims have time to become suspicious or contact others for advice.
  5. Recovery Attempts – Fraud victims’ names are widely circulated. If you have fallen prey to a previous scam, you could get a call promising to recover money that you have already lost. Of course, this “service” comes at a price. Be suspicious if people call and already know where you have invested before.

Several investment scams come with their own red flags. Below is a description of three common frauds:

  1. Pump and Dump – Messages are posted online that urge readers to buy a stock quickly. Often, promoters claim to have “inside” information about unique economic data. In reality, they are insiders who stand to gain by selling their shares after the stock price is pumped up by gullible investors.  Once these fraud promoters sell their shares and stop hyping the stock, the price typically falls and investors lose their money.
  2. Pyramid Scheme – Participants attempt to make money by recruiting new participants into the program. The hallmark of these schemes is the promise of sky-high returns in a short period of time for doing nothing other than handing over your money and getting others to do the same.  Money that comes in from new recruits is used to pay off early stage investors until the pyramid eventually collapses.
  3. Affinity Fraud – Fraudsters exploit the sense of trust and friendship in groups of people who have something in common. They enlist respected leaders within a community to spread the word about an investment deal. Fraudsters assume that the tight-knit structure of many groups makes it less likely that a scam will be detected and that victims may be more likely to forgive “one of their own.”

Information is an investor’s best tool when it comes to investing wisely and avoiding fraud.  And the best way to gather information is to ask questions—about both an investment and the person or firm selling it.

  • Think twice before investing money in any opportunity you learn about through the Internet. It is very easy for fraudsters to make their messages look real and credible.
  • Request a company’s financial statements. If you are not able to access this information, that is a major red flag. Always remember: if something sounds too good to be true, it probably is!

For additional information about investment fraud and how to avoid it, review Unit 11 of the Cooperative Extension basic investing online course, Investing for Your Future.

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