How Dividend Investing Can Help You Stay Away From Ponzi Schemes

By: ispeculatornew
Date posted: 07.21.2011 (5:00 am) | Write a Comment  (2 Comments)

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The last few years have seen many different trends in the financial markets. Unfortunately, one of them has been the explosion of frauds related to capital securities. Insider trading, market manipulation, and many other types of frauds are taking place at an increasing rate. One fraud that has been in the spotlights more than any other has been the Ponzi scheme. There have been small ones, big ones and then the Bernie Madoff one. These schemes have been happening a lot more than you would think but only the biggest ones got attention from the mainstream media.

How Ponzi Schemes Work

You can find much more detailed information but the basic concept is that investors buy shares in a fund. The manager then manages to publish falsified valuations making the returns look much better than they actually are. The effect is twofold:

-Current Investors Put More Money Into the Fund
-New Investors Come Knocking To Invest

This can go on for a long time because the basic ways such a scheme will get caught are if authorities catch on or when investors start withdrawing money which the fund often does not actually have. That is what happened to Madoff. If the financial crisis had not occurred, investors would have perhaps left their funds invested for many more years and the Ponzi scheme could have gotten much bigger. Other frauds such as Enron relied on different accounting frauds.

How Dividend Investing Can Help You Avoid Frauds

Diversification: While it is not unique to dividend investing, the truth is that dividend investors tend to have much more diversity in their holdings than the average investor’s portfolio.

Type Of Company: Generally, dividend investors tend to like long term, sustainable dividend companies such as the dividend aristocrats that have often been running for 50, 100 years or even more . While such companies can end up being fraudulent, the risk is much smaller than when investing in newer companies

Take Money Out:One of the great things about dividend investors is that they take money off of the table in form of dividends. The only Bernie Madoff that did not get destroyed were those who had taken out money over the years instead of always reinvesting into the same funds.

Dividend Investors Beware

I think it’s still important for dividend investors to look out for opportunities that look too good to be true. A company cannot keep increasing dividends by 10% per year for decades, it’s just not possible. Still, I think that as a dividend investor, my odds of being caught up in a major fraud are diminished.

Do you agree?

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2 Comments

  1. Comment by Bret @ Hope to Prosper — July 21, 2011 @ 8:47 pm

    There is an apalling lack of oversight of the financial services industry. The SEC received five separate complaints against Bernie Madoff and investigated him four times. They never even audited his books once. As you said correctly, this happaens all of the time on a smaller scale and FINRA is almost completely useless in protecting depositors.

    That is why I invest directly and manage my money myself.

  2. Comment by Stephen — July 22, 2011 @ 10:29 am

    I agree with you, but it also has to do with unreasonable greed. From what I read, all these rich people were flocking to Madoff because he was offering very high returns every year, even during down times. That should have made them a bit suspicious.

    I’m not immune to greed either. I bought some NLY because the dividend is so high, but then I didn’t pour my entire life savings into it either.

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