Beware! How not to fall for a pyramid scheme
A friend comes to you with a great investment opportunity, raving about how much money she’s made in a short time. Sounds too good to be true? It probably is. In all likelihood, it’s a pyramid scheme.
How pyramid schemes work
Pyramid schemes basically feed on our basic desire to make a fast buck without too much effort. The scheme usually lures people in with the promise of unusually high returns on an investment, with no risk. Buoyed by good returns, investors draw others in, and it becomes a “robbing Peter to pay Paul” scenario, where the people at the top of the pyramid are paid dividends from the fees of those lower down in the scheme, rather than from real investments. The bigger the base of the pyramid grows, the more unsustainable the scheme becomes, and the less likely you are to ever see your money again, let alone any profits.
How to spot a pyramid scheme
- If you hear the words “no risk” or “guaranteed returns”, then run for the hills. No investment is without risk. Even if you make like grandma and stash your cash under the mattress, there is still a chance (read risk) that you could lose it.
- Most pyramid schemes offer unbelievably high returns – in the region of 20% plus. Use the official repo rate as a baseline for comparison. This is the discounted rate at which the South African Reserve Bank lends money to commercial banks (currently 6.75%), which allows it to control inflation. Any promised return on investment that’s significantly higher is, well, dodgy.
- Don’t be shy to interrogate the “broker”. Ask him or her how long they’ve been in the investment game, what qualifications they have, whether they are registered with the Financial Services Board and which type of financial products they are allowed to provide a financial service for. By law, only people or organisations registered with the board can dispense financial advice.
- Do you have to introduce other people to the scheme? This is a biggie, and a sure-fire clue that you’re looking at a pyramid scheme. Ask yourself why would you have to bring in potential investors to make money?
- Don’t be afraid to ask where your money will be invested and the past performance of at least 5 years. If you get a vague response or are told this information is confidential, it’s a huge red flag.
- Another variation of a pyramid scheme is that you are required to buy large quantities of low-value stock items to sell. You will be expected to recruit other people to do the same, on the pretext that you will get a cut of whatever they sell.
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