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Pyramid schemes: What are they and how can you avoid them?

In the 12 months up to October 2020, Brits lost as much as £35 million to pyramid schemes.

As this suggests, they aren’t always easy to spot. Here we break down how they work, and most importantly, how you can avoid them.

Pyramid schemes: what are they and how can you avoid them?  

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What is a pyramid scheme? 

According to Action Fraud, the UK’s national reporting centre for fraud and cybercrimea pyramid scheme "involves an unsustainable business which rewards people for enrolling others into a business that offers a non-existent or worthless product."

The scheme's only source of income is new and existing members paying them money. Those buying into the organisation rarely, if ever, see any returns.  

How does a pyramid scheme work?  

Pyramid schemes start with a single person, or a small group of people reaching out to a number of individuals with promises about making lots of money quickly.

To get started, the new recruits need to invest a certain amount of money into the business, buy set amounts of products each month or pay hefty commissions. In return, they’re promised lots of money through recruiting more people. 

The founders of the scheme make the lion’s share of the money, while those further down the pyramid as well as those joining later on, rarely make much money.

As the pyramid grows and new members join, those higher up make more money, while those at the bottom have to replicate the expansion to make money themselves.  

What types of pyramid schemes are there? 

Pyramid schemes can exist in a wide range of sectors and can come in a few different forms.

Some pyramid schemes have been run entirely through chain mail, where people continuously circulate emails recruiting more individuals.  

Other schemes can be run through investment clubs. These clubs are entirely legitimate normally and are a way for people to pool together money to invest in causes and organisations.

But due to the collective nature of investing clubs, they can also be targeted by pyramid schemes that start fake clubs by convincing people to invest.

They then each get a small portion of the money by recruiting more and more people, all while continuing to invest.  

Are pyramid schemes illegal? 

Yes. Like all scams and money-making schemes, pyramid schemes are illegal.

Very simply, those running pyramid schemes are getting rich through siphoning funds from late-stage joiners who will almost certainly never make any money.

Ultimately these schemes are get-rich-quick promises that take people’s hard-earned savings for good.  

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What is the difference between a pyramid scheme and a Ponzi scheme? 

It’s not always easy to work out if something is a pyramid scheme, particularly if you’re already involved in one.

It’s not often that employees see the full financial details and arrangements of businesses they’re a part of, which makes it challenging to work out exactly where your money is going.  

But pyramid schemes aren’t the only illegal schemes aimed at making money.

While pyramid schemes make money for those at the top of the scheme through recruiting new members, other illegal schemes, such as Ponzi schemes, make money through different means.  

A Ponzi scheme only needs investors to make a single investment, with major returns being promised further along the line.

Once invested, there is little to no further involvement with the business from the investor. As with pyramid schemes, the only people making the money are those running the business from the top. 

What is a multi-marketing scheme?  

Ponzi schemes and pyramid schemes are illegal.

But both share similarities to multi-level marketing businesses (MLMs) which are entirely legal.

For instance, in both cases participants don’t receive a regular salary, work as independent contractors, are usually charged commissions and fees for being a member and need to buy a certain amount of product each month to continue being a part of the scheme.  

With an MLM though, any unsold inventory that participants have purchased will be bought back by the business, so participants aren’t punished for not selling more.

And as a result, more attention is paid to marketing and selling products themselves, as opposed to recruiting new members. Though similar, MLMs and pyramid schemes do differ.  

How to spot a pyramid scheme 

It isn’t always easy to spot a pyramid scheme if you’re already involved.

However, pay close attention to the following signs as they could mean you’re involved in a pyramid scheme: 

  • An overemphasis on recruiting: Pyramid schemes can only work when the pyramid grows — that is, when new members are recruited. If your bonuses and rewards are primarily designed to encourage you to recruit new members, this could be a warning sign  

  • You rarely, if ever, sell any goods or services: From marketing to actual selling, if there’s little commercial activity going on, it can be a sign of a pyramid scheme 

  • Large upfront costs or investments: Immediately being asked to part with sums of money is a tell-tale sign of a pyramid scheme  

Protect yourself from money-making schemes 

The best way to avoid falling victim to a pyramid scheme is to develop safe money habits.

Although almost all of the time, investing in a business is a legitimate way to support an organisation and potentially make a return, be sure to follow safe investing tips to make sure you’re investing in a legitimate opportunity: 

  • Don’t part with any money until you have the bigger picture: Investing always carries some risk. But until you’re certain about what’s being invested and what your involvement in it will be, don’t invest any money. If you’re not certain, speak to a financial adviser who can help you 

  • Understand investment risks: If it sounds too good to be true, it almost certainly is. Anything promising big returns will be taking big risks. If easy returns always delivered big money, everyone would be doing it 

  • Only invest amounts of money that you’re prepared to lose: Unfortunately, people involved in pyramid schemes rarely get their money back. So be certain only to invest small sums of money that you are happy to potentially not get back 

Pyramid schemes can take lots of money from lots of people.

But by following the right financial guidance and staying safe with your money, you can steer well away from pyramid schemes.

Speak to a financial adviser who can help you invest safely and meet your money goals.

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About the author
Kate has written for leading publications and blue chip companies over the last 20 years.