Just like the pyramids in Egypt, pyramid schemes have been around for quite awhile. The reason is simple. People are greedy. And the desire for quick and easy wealth is an invitation for a con man.
A pyramid scheme isn't really difficult to understand. The simplest way to grasp how they work is to picture a pyramid made up of people. In the top row is one person. The second row has two people. Row three will have four people. Each additional row will have more people than the row above it. The triangular shape looks like a pyramid.
Enter our con man who sells big profits to the initial investors. He counts on being able to sell his 'investment' to more and more people. He'll take the money generated from lower rows to pay the profits promised the upper rows. Although investors don't know it, money flows from the lower rows to the upper rows.
The plan works as long as enough money is collected from the lower rows to fulfill the promises made to the upper rows. Typically that's possible as long as more people are being added to the bottom of the pyramid.
There are many variations, but all are similar. Sometimes there isn't any real business activity or investment at all. The con man just takes new investment money and uses that to pay the profits already promised to the top of the pyramid. Naturally he keeps some for himself.
Sometimes our Schemer will actually invest the money entrusted to him. Naturally the real investment returns don't equal the promised profitability. He'll make up any shortfall by adding money from new investors. It's not uncommon for this type of pyramid to grow quite large before it topples. Often, the top rows are so happy with their returns that they'll tell their friends about the deal. Unwittingly, they've made it easier for the con man to keep growing the pyramid.
Some multi-level marketing plans also act like pyramid schemes. Before you send any hate mail, please notice that I didn't say that all MLMs are bad. But any plan that counts on you to recruit friends and those friends to recruit even more people could be a problem.
One way to evaluate any MLM program is to ask whether you'd buy the product if it were offered in a store for the same price. If the answer is "no" then the program will suffer pyramid-type problems.
All pyramid schemes have one thing in common. They promise returns that are larger than the business or investment can generate. To make up the difference they take money from newer participants.
So how can KC identify pyramid schemes? All share some tell-tale warning signs. In fact, unless greed clouds your vision, most pyramids will leave you feeling uncomfortable even before you've given them your money.
There are a number of questions that will point out the bad guys. Does it seem like the plan promises too much money? Investments that guarantee your principal generally pay 2% to 6%. You can find things that pay more, but they won't be as safe. And any investment that promises over 20% per year falls in the high risk category. An unusually high return is a warning sign.
A related question is - do you understand how the money will be made? Could you explain it to your spouse? If you can't explain it, you probably don't understand it. And it's important to understand how your money will make money if you don't want to lose it.
Computers have made all kinds of hybrid investments possible. But they've also allowed con men to create plausible sounding programs that are just fancy scams. Don't count on a computer to make you money. If you don't understand exactly what computations the computer is performing and how the investment makes money, it's time to run.
Finally, the oldest play in the book. "Act now! Don't let this one get away!" Remember that the con man is counting on greed to overcome your reluctance. Very few great deals disappear overnight. But an awful lot of money has been lost by people who couldn't resist the call to make a decision right away.
The bottom line? The Egyptian pyramids are shrouded in mystery and have left generations wondering how they were made. But there's no mystery to where your money will go if you invest in a pyramid scheme. The wonder is that people continue to fall for them.
About The Author: Gary Foreman has worked as a Certified Financial Planner and currently edits The Dollar Stretcher website http://www.stretcher.com/save.htm You'll find hundreds of free articles to help you save time and money. Email Gary
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