How to spot a pyramid scheme.

A pyramid scheme is a fraudulent system of making money based on recruiting an ever-increasing number of “investors.”  The initial promoters recruit investors, who in turn recruit more investors, and so on. The scheme is called a “pyramid” because at each level, the number of investors increases. The small group of initial promoters at the top require a large base of later investors to support the scheme by providing profits to the earlier investors.

Let’s assume the following: Founder Mike sits alone at the top of the heap, represented by the number “one.” Assume Mike recruits 10 second-tier people to the level directly below him, where each newbie must issue him a cash payment for the privilege of joining. Not only do those buy-in fees funnel directly into Mike’s pocket, but each of the 10 new members must then recruit 10 tier-three members of their own (totaling 100), who must pay fees to the tier-two recruiters, who must send a percentage of their takes back up to Mike. According to the hard-sell pitches made at recruitment events, those bold enough to take the pyramid plunge will theoretically receive substantial cash from the recruits below them. But in practice, the prospective member pools tend to dry up over time. And by the time a pyramid scheme invariably shuts down, the top-level operatives walk away with loads of cash, while the majority of lower-level members leave empty-handed. It should be noted that because pyramid schemes heavily rely on fees from new recruits, the vast majority do not involve the sale of actual products or services with any intrinsic value.

Unfortunately, these types of scams sometimes prey on people who need income quickly. For example, if you lost your job and are having a hard time finding a new job, you might be more willing to look into an opportunity that offers a fast return. But avoid the temptation to overlook the feeling that something is too good to be true. Instead, take a moment to calm yourself so you can make a legitimate plan after losing your job. Go over your budget—or create one for the first time—so you can manage your money in the best way possible while you try to increase your income.

How to Spot a Pyramid Scheme

Pyramid schemes and MLM sound a bit alike, don’t they? Here are some signs of a pyramid scheme, provided by the US Securities and Exchange Commission, to help you understand whether you’re considering a scam or a legitimate MLM opportunity:

  • You’re not selling something real. Legitimate MLMs sell tangible goods—many times there’s a ready-made market for them.
  • Get-rich-quick promises. If you’re being offered overnight success, get-rich-quick guarantees, or passive income promises, it’s probably too good to be true. People who make money with legitimate MLMs put a lot of time and effort into their businesses.
  • The company can’t prove it generates retail income. If the business can’t show you financial statements that demonstrate income from the sale of product, it could be generating all its income from recruiting people into the pyramid.
  • Strange or unnecessarily complex commission processes. Legitimate MLMs have easy-to-understand, product-based commissions.

The Bottom Line

Pyramid schemes are illegal in many countries. The model of profiting by using the network effect often traps individuals into recruiting their acquaintances, which can feel slimy for everyone involved and can ultimately strain relationships. Some people may shoot their shot each time and invest in multiple schemes losing money each time. Victims of pyramid schemes are often embrassed into silence and keep blaming themselves for not being tenacious enough to earn the promised returns, when in truth it’s the system that is faulty. Get rich quick schmes never work and will allways have some strings attached to it that can put people into legal trouble. Vigilance and knowledge about where your money goes are important factors that people must know, preventing them from falling pray for traps like the pyramid scheme.

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