Wednesday, April 25, 2012

Are you eating your savings?

Lately, I have been doing some thinking and reading about financial freedom and passive income. I cannot guarantee a steady stream of posts, but I will share interesting discoveries here on a one-off basis.

Today, I would like to explore the use of Savings accounts.

In its truest form, a Savings account is an account that contains your 'savings' - a percentage deduction from your monthly income that is set aside for rainy days. However, I have found - by asking others and from personal experience - that people seldom use Savings accounts for this purpose.

The average person keeps their monthly income in Savings accounts, and withdraws from the account on a need-to-use basis during the month. Many times, these withdrawals are not even backed by a budget. This is made even more convenient by the use of ATM cards  and the ability to withdraw in most banks without a conventional 'passbook'. In the end, however, this flexibility contributes greatly to the vicious cycle of month-month spending and total dependence on salaries.

Without going into great detail about the supporting concepts (interested readers may consult books such as The Richest Man in Babylon) - regular and consistent savings are the very first step towards financial freedom. Every man and woman needs to set apart a predetermined percentage from their monthly income, and ensure that this is kept untouched - to be used only for investments in viable businesses or emergencies. It is the passive income that is earned by making money (savings) work for us that starts us all on the path to financial freedom.

However, the present use of Savings accounts does not encourage that. The lack of a clear delineation between  money meant to be spent (covered by your monthly budget) and money meant to be saved (a predetermined amount) means that 'savings' sometimes get appropriated for other (un-budgeted) uses.

Enter: Escrow Account.

An Escrow account is one where you can make regular deposits - but need to consult a third party before you can make withdrawals. It goes without saying that you should NOT have ATM cards or any direct withdrawal access to such an account. The benefit to this is quite obvious - the probability for mistaken appropriations goes to zero, and depending on the chosen third party (how much respect you have for the fellow) - you need to have really valid reasons (such as a worthwhile business investment) before you can get at your money.

Having enough money to make big deals requires you to have performed excellently with a number of small deals, and it is important that we all learn to put money aside for investments and emergencies.

I suggest you read more about Escrow accounts here.


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