Monday, November 17, 2008

The so called true story of David Johnson

I now receive about one of these per day: how to become a millionaire in three (longish) easy steps. It will supposedly take only five minutes of your time, a figure I find somewhat doubtful since one of the steps includes getting 200 names from the phone book.

I spent a lot of time trying to explain to these poor misguided soul how this is not only unlikely to work, but in the much greater scheme of things it does an incredible amount of harm.

So here, once and for all, are the reasons why you do not want to be involved in this scam.

The scam claims that it is perfecly legal, while this is not the case. These schemes are against the law in South Africa. It should come us no surprise that the scam claims not to be a scam. But even if there were no law outlawing this practice, good old common sense should still tell you that there is something very wrong with this. As the saying goes: if it is too good to be true, it usually is.

This scam essentially relies on asking people to give you something for nothing. That means that it fails the number one test: you are not selling a real product, and the buyer does not get a product or a service worth R150 (some versions have been adapted to three times R70 rather than R50). After you've paid your investment, this will supposedly entitle you to receive the same favour from others.

This would be all fine and dandy if you could always find someone to invest more money, that is, you had an infinite supply. This is effectively how many legal types of insurance funds work. A medical aid, for example, is a little like a big "stokvel" or savings fund: it relies on finding young healthy people to sustain the fund. This is perfectly legal, since they sell a real product, and a new supply of young people joins the work force every year, giving you an endless supply of new investors.

This is not the case with this scheme. Whoever started the scheme made no contribution, and it doesn't take a genius to see that it has to end somewhere since you cannot breed people that fast. That means you are effectively limited to the number of economically active people in the country.

How fast will it run out? Well, lets take the numbers from the three step recipe: You can make 3.2 million if everyone sends it to 200 people, of which at least 40 responds on each level. That means that you've passed this note to about eight million people, or 16% of South Africa's population. That means that this recipe will work for about five or six people in this country.

The scheme warns against breaking the rules and quotes a couple carefully selected bible verses for "legitimacy". The bible verses are quoted out of context, but it is an angle that admittedly works quite well. Despite these warnings, there is no way in which the rules can be enforced. The scheme almost begs to be abused, since there are some opportunists who realise that it is advantageous to break the chain. You have no way of knowing whether someone has followed the rules or not.

Time for some more maths. The growth of the investor pool can be calculated through a simple geometric series. To make this more practical, lets assume that each investor manages to sign two more. This means that every layer in the pyramid has double the number of participants. As anyone who's had the good fortune of receiving tertiary mathematical education should know: the bottom-most layer always has more participants than all the upper layers put together. That means that half of the participants are at the bottom. This scam relies on cash being injected from the bottom-most three layers, which means that 87.5% of all participants are affected. When the scheme runs out of new investors, 50% will lose out on the deal, and anything between 50% and 80% will fail to make any profit at all.

The upper limit for the pyramid would be about 26 levels, since that exceeds the population of South Africa. Since a substantial part of the population is either unemployed or too young to be economically active, you will likely run out way before that. The example above assumes double the investors, but in real live way more people fall for this, which means the pyramid has way less height and consumes investors a lot faster.

The fastest way to make a million using this method is when the three layers below you sign 28 investors each. That would pull 21952 investors into the pool, and create a void of three million rand. When those people manage to recover their investment, it creates a void of 9 million. And so on and so forth...

In the end this is in fact a moral decision. Even if it costs you only R150, it does so much damage that you should avoid, even fight this scam.