Thursday, August 21, 2008

Many People Would Rather Feel than Think

According to CNN, a Ponzi scheme run by Andres Pimstein fell apart recently in Miami, Florida. A Ponzi scheme is a fraudulent investing scheme where investors are paid returns out of other investors’ principal instead of being paid from the returns of a legitimate business.

Ponzi schemes fall apart when there aren’t enough new investors to pay the existing investors. The fraud grows exponentially until the pool of suckers runs out.

What I find interesting about this story is the way that people are tricked into these schemes. Potential investors are offered guaranteed big returns in a short time. If this were a legitimate business, why wouldn’t the pitch man just borrow some money from a bank and keep the huge profits himself?

The usual explanation for why people get caught in these frauds is that greed overcomes reason. I think that is just a partial explanation. My guess is that the people, like Pimstein, who run Ponzi schemes are charismatic. Potential investors probably liked Pimstein as a person and felt good about investing with him. Reason and logic took a back seat.

It’s interesting to think about the usual advice on finding a financial advisor with this Ponzi scheme story in mind. We are told to find an advisor we like and feel comfortable with. My guess is that Pimstein would meet this test nicely.

When it comes to large dollar amounts, it is very important to think instead of feel. Big money decisions don’t come up very frequently. You can spend the rest of your time enjoying art, family, and good friends.

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