Pyramid schemes often look like good moneymakers at first glance, but you’re much more likely to lose money if you participate in one. Before you can avoid pyramid schemes, you need to understand what they are and how they work.
Pyramid schemes are a hierarchical moneymaking system where people at the top of the pyramid recruit underlings to do all of the hard work while the money funnels upward to those at the top. The people at the top can become wealthy, but those under them rarely make money at all.
How Pyramid Schemes Work
Pyramid schemes start with a single person or group of people who convince others to join their system. The small group recruited by the top person invest money or start selling things and pass a commission up to the top person. The top person collects the money without doing any work at all.
Next, the small group of initial recruits start recruiting others. This third tier of the pyramid pays to buy into the system or starts selling items and passing their commision up to those above them. The second tier people get some and pass some up to the original founder. Eventually, the third tier recruits people to work underneath them, and each person who joins sends money up the chain to those higher on the pyramid. At some point, the second tier may be able to stop working or selling and just rake in the money being sent up the pyramid to them.
Why Pyramid Schemes Are a Scam
Where pyramid schemes fall apart is at the bottom of the pyramid. The lower the level, the less likely you are to be able to recruit more participants. You end up passing money upward to those above you without seeing any return for your time and effort.
Many people are sucked in by the idea that they can recruit people under them to send money upward into their pockets. But recruiting new participants is difficult and time consuming, and most people you recruit will give up once they realize that all they are doing is spending a lot of time and effort to line your pockets instead of their own.
One way to recognize that something is a pyramid scheme, and therefore a scam, is to note whether any actual products are being sold or any service is being provided. In some cases, the promise is simply that if you give money to your recruiter, later recruits will pay up to you. This type of scheme is actually illegal.
Others pyramid schemes use products or services to give the scheme a veneer of legitimacy. If the sales of products is secondary to the recruitment of new members in the scheme, that’s a key indicator. One way to tell this is to note whether people outside the scheme are actively buying the product.
Beauty product companies often follow a pyramid-like model, but people outside the company actively seek out and buy the products. Because of this, it isn’t technically a pyramid scheme. The seller can actually make money simply selling the products even if they never recruit any other participants.
Many companies with a similar model that sell cheap household goods, mailing lists, or low-demand products aren’t quite pyramid schemes, but they have the same inherent problems. Family members or close friends might buy the items, but the demand for them simply isn’t high enough for the seller to successfully make money just as a salesperson. Recruiting others to join the scheme is the only true path to profit, so the scheme is a pyramid and destined to fail.
Do Most Participants in Pyramid Schemes Lose Money?
Approximately 90% of people in a given pyramid scheme lose money. The person or small group at the top may make money, but everyone else walks away with less than when they began.