“Ponzi” schemes promise high financial returns or dividends not available through traditional investments. Instead of investing the funds of victims, however, the con artist pays "dividends" to initial investors using the funds of subsequent investors. The scheme generally falls apart when the operator flees with all of the proceeds or when a sufficient number of new investors cannot be found to allow the continued payment of "dividends."
This type of fraud is named after its creator—Charles Ponzi of Boston, Massachusetts. In the early 1900s, Ponzi launched a scheme that guaranteed investors a 50 percent return on their investment in postal coupons. Although he was able to pay his initial backers, the scheme dissolved when he was unable to pay later investors.
Tips for Avoiding Ponzi Schemes:
- Be careful of any investment opportunity that makes exaggerated earnings claims.
- Exercise due diligence in selecting investments and the people with whom you invest—in other words, do your homework.
- Consult an unbiased third party—like an unconnected broker or licensed financial advisor—before investing.