Money Management for Unregulated Securities

[stochastic]

The problem with many unregulated securities is that it is hard to make sure something is a ponzi scam or not.  What I try here is to give money management advise when dealing with unregulated securities or investments.

There are 3 fundamental rules:
1.  Never play around with money or time that you can't afford to lose.
2.  Never reinvest your earnings from one asset into the same asset.  This means, always take your dividend, distribution, or interest payment and keep it or use it for something else.
3.  Always draw down your investment over time.

What is a ponzi?
A Ponzi is a fund that pays investor A with the money deposited from investor B.  Ponzi are fraudulent investment funds that act on investor greed to steal their money.  Ponzi's can sometimes be discovered by an  unusually high interest rate, but if a business is capable of growth or pays out most of its income then they give high dividends.

So how to protect your investment? Following the 3 rules above.  In the following example, Alice invests 10,000 in some unregulated asset that promises her 7% a week.  Each week she makes 7% on her total balance, withdraws the interest that she makes, and withdraws an additional sum of money equal to her interest that she made that week.  Each week's interest decreases but her total amount of money being risked also decreases.  At 10 weeks after her initial investment, she has her original 10,000 back, but now she is making pure income.

Example,
Name: Investment Fund A (IFA)
Weekly return: 7% (crazy)

Spreadsheet:
https://docs.google.com/spreadsheet/ccc?key=0AncUp77iGwCjdFBsNE5DODA4M2hwLXlBWjhVMHE1SHc

[FreeMoney]

Also, just because something has normal or bad returns doesn't mean it's safe.

Also, even if you are somehow sure something isn't a ponzi, it's still probably a bad idea to send money to a stranger with (or without) a plan.

Also, regulated securities suck too.

[Seal]

Simple straightforward advice. Common sense a lot would say. No doubt this will always need repeating.

I'd add another one:

4. Dont make investment decisions using emotions (especially fear and greed). Use common sense, pick a strategy and stick to it.

[niko]

Regulate it yourself, in the sense that you spend time getting to know the people behind the project you are planning to finance, scrutinizing their plans, and generally doing the job that you trust the government with in the case of regulated securities.

[ssaCEO]

Regulate it yourself, in the sense that you spend time getting to know the people behind the project you are planning to finance, scrutinizing their plans, and generally doing the job that you trust the government with in the case of regulated securities.

The problem with that is it's frequently impossible. Case in point, I know a long-term, savvy investor (in the real world, not in Bitcoin) who got taken for $250k recently by a new startup that was probably just a shell. They had a great business model, great product, and both an extremely personable CEO and CFO who each took time to get to know their investors, and were always available to answer the phone. The only problem that stood out - to me - was that they were too available to answer the phone for an investment of that size. I didn't tell my friend this, since his money was already sunk and there wasn't much point in telling him to be more paranoid.

This was a real-world security, not some shady garbage floated on the internet. It wasn't strictly a ponzi, since they didn't actually pay anyone anything; the founders just pretty much declared bankruptcy under suspicious circumstances and bailed themselves out.

So points 1-3 apply, but I have to say that getting to know the people behind an investment doesn't prove anything. You just need to have a sixth sense for when you're being conned. Start with the assumption that you're always being conned. Work backwards from there until you trust somebody. Matthew Wright gave me endless shit for calling Pirate a ponzi, since that whole thing started. "How can you prove it's a ponzi?" He kept asking. Well, prove it isn't. Because until proven otherwise, anyone with their hand out is suspicious.

[niko]

^sure, getting to know people doesn't prove anything, but it does make scamming much harder. Most scammers would rather give up on you and go for easier targets. In some sense, the only reason why my advice works is because not everyone is following it.

[meebs]

Also, regulated securities suck too.

AKA "There are lots of great securities out there, but lots of bad ones as well. Don't invest in what you don't understand. "

[repentance]

"How can you prove it's a ponzi?" He kept asking. Well, prove it isn't. Because until proven otherwise, anyone with their hand out is suspicious.

This needs to be repeated over and over.  The onus is on those seeking your funds to prove their legitimacy.  It's also on potential investors to verify the accuracy of any information they're given.  Just because something sounds plausible doesn't mean it's legitimate.  Scammers know that you want to believe.  

Most scammers would rather give up on you and go for easier targets. In some sense, the only reason why my advice works is because not everyone is following it.

This isn't necessarily true.  Many successful, long term scams involve cultivating the appearance of a personal relationship with the target, leading the target to believe that they're in some way special - that's one reason why some people don't cut and run when they first lose money in a scam but continue to invest more.  Accepting that they're being scammed would call their personal judgement of people into question, not just their financial judgement.  Scammers know how to exploit that "personal" relationship for their own benefit.