Scams, Schemes, and Scum: Pyramid Schemes

All this week, we’re looking into some of the most popular scams used by ne’er do wells to take your money.  Today’s subject is especially diabolical, as it attempts to convince you to give up your money voluntarily, and then convince others to do the same thing.  These schemes also lose points for tarnishing the name of one of the Wonders of the Ancient World.  Yes, this episode looks at pyramid schemes.

The Scheme

The basic promise of a pyramid scheme is simple; by making a one-time payment to someone higher on the pyramid, the investor will get a place in line and will, as more people join, make many times their initial deposit back.  All they need to do is recruit more people to the scheme (or, as it will likely be called, the ‘investment opportunity’) and they and all the other investors can make many times your initial investment, all by just getting other people to join the investment.  It’s a simple way to become rich, right?

Sadly, these aren't the pyramids we're discussing
Sadly, these aren't the pyramids we're discussing

As with many quick and easy ways to become rich you’ll hear about, there are some issues.  If you get in the scheme near the start, you can profit (at least, until the authorities find out about your involvement), but the bulk of the participants end up paying money for their involvement with no return.  The only way to keep the profits flowing is to find an endless series of new participants.  Since the human population is finite (and squirrels tend not to have money to invest), eventually the whole scheme will fall apart, with the latest recruits unable to find enough new participants to recuperate their investments.

An Example Scheme

Let’s say that I decide to start a pyramid scheme.  (As always, I’m a diabolical character in these examples.)  I recruit three people, offering to tell them how to make a huge profit with minimal work, after they pay a fee of $1000.  I pocket $3000 and walk off laughing, after telling these first three how to recruit others to our scheme.  They each go out, recruiting three more people, who in turn recruit three more people.  The scheme works well for a while; everyone in the first few levels gets $3000 after their $1000 ‘investment’, a 200% return on their money.

The problem is that the number of people required increases exponentially.  After five rounds of each individual participant needing to find three new people to join, there will be 81 people needed; high, but far from impossible.  More than 19,000 people are needed after ten rounds, and nearly 5 million people (the population of several small states) after fifteen rounds; as you can see, the number of needed people quickly becomes very high.  After a mere twenty-two rounds, 10 billion people are needed to maintain the scheme, an impossible level of people given the current world population.  The people in the last round of the scheme (which will likely occur way before it requires the whole world population to participate) will get stiffed, meaning around 75% of the pyramid scheme participants will lose their money no matter what.

How to Protect Yourself

Understand How You Will Make Money – Understand how your investments will work BEFORE you put any money into them.  If all or the vast majority of your profits come from recruiting other people to the business rather than selling a product or investing your money, you’re likely looking at a pyramid scheme.  Proceed with caution and behave accordingly.

Be Wary of Network Marketing – Network Marketing and Multi-Level Marketing, usually through companies like Amway and Tupperware, tends to get a bad name, as well as being associated with pyramid schemes.  There are some disturbing similarities, the profits from recruiting new people being a big one, but some of these can represent legitimate opportunities.  (My aunt swears by Avon, for example.)  Just be aware that there can be a fine line between the legitimate opportunities and the scams, and do plenty of research before committing any money to anything.

Be Skeptical – Hopefully, you’re experienced enough in life to realize that getting massive returns on your money in a short period of time with almost no work is tough, if not completely impossible.  Don’t worry that you’re missing a great opportunity by not joining in on a touted investment ‘opportunity'; there are enough legitimate, good opportunities available without trying to shoot the moon.

That’s all there really is on pyramid schemes; don’t be suckered the next time your cousin calls you, telling you about an amazing investment opportunity, if you just help him find five more investors, and you’ll be alright.  Let him know what you’ve just learned, and hopefully he hasn’t put up his money yet.

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