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Investing Safely: Recognizing Ponzi Schemes

By: Holly Benedetto12.08.22
Senior couple sitting and solving a financial issue together

If it sounds too good to be true, it probably is. If someone asks you to invest and promises impossible returns on your money, such as guaranteeing that your money will be doubled or tripled with no risk, it’s probably a Ponzi scheme.

Knowing how to recognize different types of fraud is a key component to financial literacy. There are many types of investment scams, but one of the most famous is known as the Ponzi scheme.


What is a Ponzi Scheme?

A Ponzi scheme is different from the similarly named pyramid scheme.

In a pyramid scheme, members must recruit other members under a promise of payment or reward for recruiting those new members. As the recruiting multiplies, finding new members becomes impossible, and most members are unable to profit.

Comparatively, a Ponzi scheme is a form of fraud which generates returns for earlier investors using funds from new investors. The scheme leads its victims to believe that the business is legitimate and that profits made are from sales or business investments. The victims are unaware that the other investors are the source of the funds. These schemes can be sustained as long as new investors continue to contribute money and investors don’t cash out their funds all at once.

Both schemes eventually unravel when there are no longer new investors or enough money to pay everyone involved. Historically, some Ponzi schemes ended when the operator vanished and took all the money.


Some red flags of Ponzi schemes according to the U.S. Securities and Exchange Commission (SEC) are:

  • High returns with little or no risk – Every investment carries some risk, especially higher-yield investments.
  • Overly consistent returns – Returns should reflect market conditions and typically aren’t always positive.
  • Unregistered investments – Investments should be registered with the SEC or the state.
  • Unlicensed sellers – Investment professionals and firms must be licensed or registered according to federal and state laws.
  • Secretive, complex strategies – Avoid investments you can’t understand or get complete information about.
  • Issues with paperwork – Check account statements for errors.
  • Difficulty receiving payments – There should be no missed payments or pressure to stay for higher returns when cashing out.


History of the Name

Ponzi schemes are named after 1920s investment scammer Charles Ponzi, though he was not the first to use this pattern of fraud. Interestingly, the methods he used were described in two separate novels written by Charles Dickens approximately 80 years before Ponzi’s scheme.

In the early 1900s, a Universal Postal Union congress introduced “international reply coupons” to Universal Postal Union member countries throughout the world. The bearers of these coupons could redeem them for postage stamps in their local country. These coupons helped American immigrants keep in touch with their family members back home, as they could afford to buy stamps, but often the family they left behind could not.

In 1919, Charles Ponzi realized that, if one went to a European post office with American dollars and brought the coupons to the United States to cash them in, the U.S. postage received would be many times more valuable than the U.S. currency used to purchase it.

He calculated that, for every $1 spent on coupons, he could earn $5 when he redeemed them for stamps. With the large profit, he could buy more and redeem more. However, he would need to employ people to line up and collect stamps, then pay to mail them to the United States, which would likely cost more than the potential profits.

With this information in mind, Ponzi decided to not buy stamps at all, but convince people to invest in the concept. His company, known as Securities Exchange Company, promised 50% returns in 45 days or 100% returns in 90 days. During the 1920s, people were looking for ways to make money and eagerly jumped at the opportunity.

The scheme was simple: Ponzi didn’t invest the money he collected, but rather redistributed it to the investors and called it a profit. He was able to maintain this system until August 1920, when The Boston Post began investigating his company. The newspaper's investigation led to Ponzi’s arrest by federal authorities, where he was charged with several counts of mail fraud. That November, Ponzi was sentenced to five years in prison.


Targets of Ponzi Schemes

Ponzi schemes didn’t end with Ponzi’s arrest, and have continued into the 21st century. As with many types of scams or fraud, these schemes tend to target vulnerable populations.

Many seniors have spent decades saving and investing, making them an ideal target for a Ponzi scheme. Protect the funds that you or your loved ones have put aside for retirement by thoroughly investigating all potential investment opportunities and err on the side of caution with low-risk, well-known investment channels.

New technologies are just as susceptible to fraud as traditional investment methods. Digital currencies, such as Bitcoin, are virtual funds which can be traded in online exchanges for conventional currencies or used to make purchases. Scammers take advantage of the newness and complexity of this concept to find victims.

Virtual currency Ponzi schemes may arise in the form of an unregistered currency or trading platform. They promise similar high returns that others have seen circulating the internet and capitalize on the fear of missing out on the next big thing. Those who are inexperienced in virtual currency buying and trading are frequently exploited, but even experienced traders can fall victim to investment schemes.


Report Fraud or Get Help

If you think you have encountered fraud, or have a question or concern about an investment, please contact the SEC, FINRA, or your state securities regulator to report the fraud and to get proper assistance.



U.S. Securities and Exchange Commission

Office of Investor Education and Advocacy
100 F Street, NE
Washington, D.C. 20549-0213
(800) 732-0330


Financial Industry Regulatory Authority (FINRA)

FINRA Complaints and Tips
9509 Key West Avenue Rockville, Maryland 20850
(301) 590-6500


North American Securities Administrators Association (NASAA)

750 First Street, NE
Suite 1140
Washington, D.C. 20002
(202) 737-0900


Choosing a Safe Investment Partner

When seeking new investment opportunities, it is always safest to go with a trusted financial partner or known investment firm. American Heritage’s Investment & Retirement Center (IRC) will meet with you to evaluate your unique goals and investment needs to help grow your funds.

Practice safe investing and check the background of investment professionals associated with us by using  FINRA's Broker Check.

The American Heritage Investment & Retirement Center program is offered through LPL Financial (LPL), a registered investment advisor and broker dealer (member FINATA/SIPC) focused on serving credit union members.

Set up a complimentary consultation with our team today!



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