Pyramid Schemes
Pyramid Schemes
A pyramid scheme is a moneymaking scheme that promises investors unusually high returns on their investment. The concept of a pyramid scheme is quite simple and should be easy to identify, however, it is often cleverly disguised as a legitimate business. In some cases a product is offered and in others the scheme is marketed as a highly profitable investment opportunity. Unfortunately, many of these schemes have cost millions of people their savings. Pyramid schemes are illegal in South Africa.
- "Ponzi schemes" are named after Charles Ponzi, a Italian businessman who lived in the U.S. and Canada. One of his investment schemes involved buying postal reply coupons in other countries and redeeming them for a higher value in the United States. He promised investors \(\text{100}\%\) profit within \(\text{90}\) days of their investment. As the scheme grew, Ponzi paid off early investors with money from investors who joined the scheme at a later stage. Ponzi's fraudulent scheme was exposed and investors lost millions of dollars. He was sent to prison for a number of years.
- South African Adriaan Nieuwoudt started a pyramid scheme commonly referred to as the "Kubus" scheme. Participants bought a biological substance called an activator that was supposed to be used in beauty products. The activator was used to grow cultures in milk that were then dried and ground up and resold to new participants. The scheme had thousands of investors and took in approximately \(\text{R}\,\text{140}\) million before it was declared an illegal lottery.
A pyramid scheme starts with one person, who finds other people to invest their money in the scheme. These people then enrol more people into the scheme and the base of the pyramid grows. The money invested by new investors goes to participants closer to the top of the pyramid. This is unsustainable because it requires that more and more people join the scheme and the growth must end at some point because there are a finite number of people. Therefore, most of the investors lose their money when the scheme collapses.
The South African Reserve Bank has launched a public awareness campaign, “Beware of oMashayana (crooks)”, to help educate people about pyramid schemes and how to identify them.
Beware of oMashayana
So, you think you’ve found the perfect investment? Regular high returns with no risk? Be careful. Don’t lose all your money. If it sounds too good to be true, it’s probably a Pyramid or Ponzi scheme.
What is a Ponzi scheme?
A Ponzi con-artist will only ask you to give them money that they say will be invested in a scheme or project, such as supposed property developments; bridging finance; foreign-exchange transactions; venture capital to other companies; or share units. The scheme operator promises to give you back much more money than you have given them initially, in a very short space of time.
What is a pyramid scheme?
A pyramid con-artist will offer you the chance to make quick money for yourself, often by selling something. You pay a joining fee, buy the product and then sell it. They tell you that the more people you get to sell for you, the more money you will make. It’s easy for the first people to introduce new members, but soon everyone is part of the scheme and it gets harder to find new members to join. For example, the con-artist recruits \(\text{6}\) people who each pay a \(\text{R}\,\text{100}\) fee. Each of those people has to recruit \(\text{6}\) people. There are now up to \(\text{36}\) people. Now, those \(\text{36}\) people each have to sign up \(\text{6}\) people – this equals \(\text{216}\), and by the time you have to get to level \(\text{10}\), you have to get \(\text{60}\) million people to join to keep the scheme going. This can never work.
What is the difference between a pyramid and a Ponzi scheme?
The main difference is that with a pyramid scheme you have to work or sell to recruit investors, while with a Ponzi scheme the con-artist will only ask you to invest in something (for example, property development). Both schemes are illegal.
What can I do to protect myself?
You are your own best protection. It is your responsibility to make sure that you never give your money to any company or person that is not registered as a deposit-taking institution in terms of the Banks Act.
Why is handing my money over so risky?
When you hand over your money (notes and coins) to another person who then loses the money, steals it or goes bankrupt, you only have an unsecured claim against that person or their estate and you might not get all your money back.
Why is it safer to hand my money to a bank?
Banks and investment companies have to be registered so that they can be regulated and supervised, to make sure that your money is safe. Unregulated and unsupervised persons and groups don’t follow these rules and your money is at great risk with them.
Summary
- Always keep the rate of interest per time unit and the time period in the same units.
- Simple interest: \(A = P(1 + in)\)
- Compound interest: \(A = P(1 + i)^n\)
- Simple depreciation: \(A = P(1 - in)\)
- Compound depreciation: \(A = P(1 - i)^n\)
- Nominal and effective annual interest rates: \(1 + i = ( 1 + \cfrac{i^{(m)}}{m} )^{m}\)
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Future value of payments:
\[F = \cfrac{x[(1 + i)^{n}-1]}{i}\]Payment amount:
\[x = \cfrac{F \times i}{[(1 + i)^{n}-1]}\] -
Present value of a series of payments:
\[P = \cfrac{x [1 - (1 + i)^{-n} ]}{i}\]Payment amount:
\[x = \cfrac{P \times i}{[1 - (1 + i)^{-n}]}\]
This lesson is part of:
Finance and Growth