High-yield investment programs, or HYIPs, are one of the hottest investment scams today. The scam purports to offer investors extremely high rates of return on their money, but in reality most participants will have their entire investment stolen.

In 2009, the U.S. Securities and Exchange Commission (SEC) issued a warning to investors about HYIPs and similar banking-related investment frauds. The Financial Industry Regulatory Authority (FINRA) has stated that virtually every HYIP it has reviewed appears to be fraudulent. (For more, see Affinity Fraud: No Safety In Numbers.)

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The Lure of High Returns
HYIP scams are readily identifiable by the incredibly high rates of return they advertise to lure in victims. In the current low interest environment where banks are offering less than 2% interest annually on your deposits, HYIPs appear to offer a very lucrative opportunity.

HYIP programs claim to make extraordinary returns through a variety of implausible stories, including stock market trading, sports betting or other alternative investments. A quick survey of several HYIP scams showed advertised rates of return ranging from 100% per day to 0.5% per day. (For more, see Are Structured Retail Products Too Good To Be True?)

These unsustainable rates of return clearly indicate that these are not real ventures. Consider what you personally could do if you needed to raise money for a business venture. One of the easiest things to do would be to take a cash advance from your credit card, and pay an interest rate of perhaps 20% per year. This is a high interest rate.

But let's say that alternatively, you could set up a HYIP-type program where you could loan money from investors for 1% interest per day. If you chose this option, you would be paying an effective rate of interest of about 3,600% per year! Any legitimate businessperson would be able to obtain financing at a lower rate.

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Just Another Ponzi Scheme
So how do these HYIP schemes manage to pay over 3,000% interest rates when banks pay 2%? The short answer is that they don't. In reality, a HYIP is just a Ponzi scheme. The money from new investors is used to pay interest to old investors. This creates a need for new investors, which increases exponentially.

The more money that is invested, the more new money must be obtained to continue paying old investors. At some point, it becomes impossible to bring in enough new money to keep the scam going. At this point, having accumulated the most money possible, the organizer of the HYIP takes all of the money invested and disappears. (Confused? Check out What's The Difference Between A Ponzi Scheme And A Pyramid Scheme?)

If It Seems too Good to Be True ...
It is easy to spot the vast majority of HYIP scams. Many HYIPs claim to offer such absurdly high rates of return that even the most naive of investors should be skeptical. For the most part, you can avoid these scams just by following the old rule: if it seems too good to be true, it probably is.

Note that for a while, it is possible for a HYIP to pay out returns to the first people in on the scheme. This is important because this allows HYIPs to gain good reviews from real investors in order to lure in others. Don't fall for it. You never know when the scammers will close up shop, and your money will be long gone.

The SEC suggests you watch out for the following signs of HYIP fraud:

  • Excessive, unsustainable returns
  • Schemes involving fictitious financial instruments
  • Secrecy surrounding transactions
  • Offer a supposedly exclusive opportunity
  • Vague and inordinately complex investment pitches

The SEC advises that individuals that have information about HYIP scams should contact the SEC's Division of Enforcement.

The Bottom Line
When it comes to investing your money, don't be drawn in by scams that seem too good to be true. Stick with established financial institutions and investments that are clearly legitimate. If there is any doubt, do not hand over your money. (To learn more, check out The Biggest Stock Scams Of All-Time.)

Find out what happened in financial news this week. Read Water Cooler Finance: GM's Dramatic Return.

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