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Identifying And Avoiding Investment Scams (Part I)

You've worked hard to build your nest egg, and you want to make sure it lasts as long as you do. What's more, you understand that making your money last means keeping it growing well into your retirement.

Occasionally, you'll run into what seem to be opportunities for outstanding investments -chances to make a lot of money quickly, to cash in on "guaranteed" returns, or to "get in on the ground floor of the next big thing." These offers are becoming more and more common as the richest generation of Americans reaches retirement.

Such "opportunities" may be tempting, but they frequently are not all they seem to be. The saying "If it sounds too good to be true, it probably is" may be a cliché, but it's one that bears remembering.

Here's a look at common investment scams and the keys to recognizing and avoiding them:

•Pyramid scheme. Also known as franchise-fraud or chain-referral schemes, these scams promise tremendous returns as long as participants recruit other new investors. They often cast themselves as franchise or distribution operations and frequently tout the benefit of allowing one to work from home.

The key to identifying such a scam is to ask where the real money comes from. If the main revenue generator comes from signing up other distributors rather than from actually selling a product or service, it's a pyramid scheme. Many so-called multilevel marketing operations are actually pyramid schemes in disguise, so eye them with suspicion.

Over the long haul, pyramid schemes are mathematically doomed to failure. Worse, the scheme will contain the overwhelming majority of participants at the very moment it collapses. For that reason participating knowingly in a pyramid scheme isn't just bad business-it's morally and ethically wrong.

•Ponzi scheme. Technically a type of pyramid scheme, a Ponzi scheme promises outsized returns to a small group of investors, then recruits a second set and uses some of their money to pay profits to the first group (often without informing the original investors about the source of their "return"). The original investors, delighted with their success, tout it to another group, and so on. Eventually, this scheme breaks down and the scammer usually disappears.

•Affinity scams. This name describes the scams' methods more than their structure. They prey on members of a group and are often perpetrated by people who are, or pretend to be, part of the group. Often, the scammers will target a religious or ethnic group, earn the trust of its leaders, and then carry out a pyramid scheme or other con. The moral: Don't trust someone's investment advice just because you have things in common.

•Investment mismanagement. Unscrupulous brokers and agents cut corners, charge excessive fees without explanation, or make unauthorized trades. Some of these ne'er-do-wells are recruited by scammers with the promise of big returns. Before investing with anyone new, make sure he or she is properly accredited and fully discloses fees and trading policies.

Watch for Identifying And Avoiding Investment Scams (Part II) next week.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.