I recently read a book titled Breaking Through: India's Stories of Beating the Odds on Poverty. In one of the chapters of the book the author Meera Mitra recounts the story of Kamlesh, who had invested in a Ponzi scheme called Jan Sewa.
A Ponzi scheme is essentially an investment fraud where money brought in by new investors is used to pay off old investors whose investments need to be redeemed. It lures investors in by promising a much higher rate of return in a very short period of time in comparison to the other investment avenues available in the market at that point of time.
In case of Jan Sewa, things were a little different. As Mitra writes: "There was a religious overtone to the whole thing. Kamlesh, as an intending participant, made her daan (charity) of approximately `2,000. This gave her the Jan Sewa membership card... Kamlesh's card gave her quality food consumables with delivery spread over four months."
These food consumables were sold at a lower price than what had to be paid for buying similar products at a government shop. Further, the price of these food consumables was half their market price. Hence, for Kamlesh and many others like her, this seemed like an out and out win-win situation. To top it off, they did not have to stand in queues as they had to when they bought stuff from a government shop.
Soon, electronic products also became available under the scheme. All you had to do was pay the full price, buy an electronic product and over 50 per cent of the price you had paid for the product would be returned to you. Through this Kamlesh became an owner of a Nokia phone and a Samsung refrigerator. And so did others.
Soon like any other Ponzi scheme, Jan Sewa started accepting cash deposits. It was promising extremely high rates of returns. "With 100 percent return in barely six weeks, Kamlesh became cash rich. The return on cash was also fast," writes Mitra. With such high returns the scheme caught on and many new investors entered into the scheme.
No one bothered to ask the question as to how the scheme proposed to generate such high returns in such a short period of time. In comparison, a fixed deposit paying an interest of 9 per cent per year would take 8 years to give 100 per cent returns. And here was a scheme doubling money in six weeks.
A Ponzi scheme keeps running till the money being brought into it is greater than the money leaving it. The moment this changes, the scheme collapses. Not surprisingly, this is precisely what happened with Jan Sewa as well. As the scheme became too popular, it ultimately collapsed because the number of new investors entering the scheme couldn't keep going up at a very fast pace.
Kamlesh lost a lot of money when the scheme shut down and was socially ostracised as well. As Mitra writes: "Kamlesh, wounded by the loss of her hard-won earnings and dignity, went about her work in homes, staying clear of those whom she had once motivated (in good faith) to invest with a promise of better times. Kamlesh still feels that the Jan Sewa scheme was a good one, though it was caught in entanglements, which made it fail."
Kamlesh belonged to the lower strata of society and was illiterate. That could perhaps be one explanation of why she got carried away and ended up investing a lot of money in a Ponzi scheme. But that, as we know, is not always the case. All kinds of people get caught up investing in Ponzi schemes and lose a lot of money in the process.
Why is that the case? When a good amount of money is to be invested, why don't people spend some time in trying to figure out whether the investment will turn out to be a safe one. In his brilliant new book Misbehaving: The Making of Behvioural Economics, Richard Thaler perhaps has an answer.
He writes: "The incentive argument [is used] to suggest that when the stakes are high and the choices are difficult, people will go out and hire experts to help them."
But that, as we know, is not the case at least when it comes to figuring out where to invest money. People are ready to invest their money just about anywhere as long as they don't have to think too much about it. Why? As Thaller explains: "It can be hard to find a true expert who does not have a conflict of interest," writes Thaler. The amount of commission an 'expert' makes while selling a financial product remains an important consideration while deciding what investment scheme to push.
But there is something beyond this as well. As Thaler writes: "It is illogical to think that someone who is not sophisticated enough to choose a good portfolio for her retirement saving will somehow be sophisticated about searching for a financial advisor."
And there is a lesson in this for all honest financial advisors. "Many people have made money selling magic potions and Ponzi schemes, but few have gotten rich selling the advice, 'Don't buy that stuff'. And that best explains why selling the right finance advice is a tough job.
Vivek Kaul is the author of the Easy Money trilogy. He can be reached at [email protected].
This column appeared in the August 2015 Issue of Wealth Insight.
This article was originally published on September 03, 2015.
Ask Value Research 
New episodes every Friday 
New Process Alert 
Seems like you've uploaded a wrong QR code. Please upload the QR code downloaded from MF Central platform.
