Why Smart People Fall for Investment Scams

October 15, 2019

The authors of ‘Financial Serial Killers’ explain how not to get duped

By Tom Ajamie and Bruce Kelly for Next Avenue | Photo: Thinkstock

Oct. 25, 2016—There are many reasons why we fall for investment scams. As we understand and realize these factors, we are less likely to fall prey to investment scamsters — who we call “financial serial killers.”

Robert Cialdini, formerly Regents’ Professor of Psychology and Marketing at Arizona State University, says the root cause of people falling victim to a financial fraud is their uncertainty about the details of the financial environment. When people feel uncertain about financial decisions, he notes, they look outside themselves, and this sets them up for the fraud.

Two Ways “Experts” Con Us

To seek reassurance and help reduce their uncertainty, people often turn to others who appear to be experts — or at least to ones who proclaim to be experts. Expertise and trustworthiness are the two components that constitute a great authority in most people’s minds.

Certifications and diplomas are symbols of expertise signifying that someone is an “expert.” These kinds of trappings can be sometimes genuine, but they can also easily be counterfeited to convince people that their holder is somebody who knows what he or she is talking about.

Cialdini notes that Bernie Madoff, who perpetuated what was likely the greatest financial fraud in history, “sat on a governing commission that was designed to offer policing policies for the financial industry.”

The second place we look when we are uncertain is to our peers. “That’s why so often [investment] scams turn out to be affinity scams,” says Cialdini. “Groups that share some kind of connection.” People use groups they belong to as a source of good information. Cialdini says that they think: ‘What are the people like me doing and telling me to do? I can usually trust that.’

Madoff had emissaries of various sorts in Jewish congregations and in golf clubs. He had people who were selling access to his funds to the people they were friends with within those organizations.

We tend to be willing to say “yes” to our friends because we think they’re steering us right and because it’s very awkward to say “no” to a friend who comes to us with a great proposition — and is staking his reputation and status on it.

The Club You Don’t Want to Join

Another compelling factor that leads us to fall for investment scams is the perceived scarcity of the opportunity.

“We are drawn to those opportunities that only a few are going to be allowed in or you have to have a certain level of finances in order to be allowed in or you have to know somebody to be allowed in,” explains Cialdini.

These psychological impulses come from a number of human needs. We want to feel special. We want to be thought of as one-of-a-kind. We want exclusivity. The secretive, or exclusive, factor plays into our psychological need to feel special.

All the while Madoff was giving the appearance of running an exclusive operation, he actually represented thousands of people. But he made all his customers feel like they were part of a very exclusive club, mastering his deception.

Madoff’s tack — and that of many other fraudsters — was to keep his investment formula secret. Cialdini says that “if anybody challenged him, he threatened to kick them out.”

Cialdini says fraud victims often fall for the scarcity principle when they’ve just lost money on another investment. “When people are dealing with the recent experiences where they’ve not done well, they don’t want to lose any more. So you can tell them that unless they move, they’re going to lose the opportunity,” he says.

Cialdini has seen this firsthand working with AARP investigating phone scams of the elderly. “They get burned and are so ashamed that they become vulnerable to the next scam so they can recoup their losses. They don’t want to think of themselves as losers and they don’t want their family to think of them as fools and idiots financially. So they wind up getting in again and losing yet another chunk of their savings,” he notes.

Lessons and Takeaways

To avoid being duped into investment scams, you need to be careful about doing business with people you know a little. Simply because you attend the same church or synagogue as someone does not mean that he is qualified to manage your money or has your best interests in mind. Look objectively at his qualifications. It’s better to select a money manager by interviewing two or three candidates and narrowing the choice from there.

You also need to prevent yourself from making investment decisions based on emotions. Cialdini says we often make decisions based on emotions and rationalize them later. But “if we truly take a step back and try to be dispassionate about a decision because it’s going to involve considerable resources, we can do a pretty good job of countering a purely emotional decision,” he notes.

Don’t be gullible, either. Otherwise smart and cautious people sometimes are when a financial serial killer approaches them with an investment. Says Cialdini: “I think that a lot of people who are not normally gullible can get caught up in these scams because it has to do with the distortion of — the undermining of — normally good decision-making principles.”

7 Questions You Need to Ask

White-collar crime can and does pay — and it pays because of you. To prevent you from becoming a victim, we’ve pulled together seven questions to ask:

Is the broker or adviser using high-pressure sales tactics and telling you that you must invest right now?
2. Is the broker or adviser pressuring you just as you are dealing with a dramatic life change, like the death of a loved one, particularly a spouse who handled the household’s money? (People are very vulnerable after the death of loved ones.)
Is the broker or adviser telling you the investment has a no-risk, guaranteed return of 10 percent, 15 percent or higher?
4. Can you find information about the broker or adviser and his firm at public websites such as FINRA.org, www.cfp.net or www.sec.gov? (If you can’t, you should probably stay away.)
Does the broker or adviser say the investments or strategies are too complex to explain or that they’re top secret?
Is your investment adviser too perfect? Like Madoff, is he or she generating returns that closely resemble each other year in and year out regardless of the market’s fluctuations?
Did the investment “opportunity” come through email? Increasingly con artists use that method of communication to target victims, the SEC warns. If you receive an unsolicited email from someone you don’t know with a “can’t-miss” investment, your best move is to pass up the “opportunity.”

(This article was adapted from the book, Financial Serial Killers: Inside the World of Wall Street Money Hustlers, Swindlers, and Con Men by Tom Ajamie and Bruce Kelly.)