Saturday, October 27, 2007

Debt Reduction or Debt Production

Hopefully this is not your wealth building strategy.

Imagine being able to steal untold millions of dollars in plain view without getting caught. Impossible you say. Be careful because you are most likely a victim of this heist. In fact, you may actually be giving these thieves referrals so that they can dupe your friends and family.

For a while I was not aware of how the scheme worked. It was after talking to someone who was in on it that I got to see the entire operation at work. I have to say it is quite an elaborate conspiracy. It involves so many people. I couldn’t believe I fell for it for so many years.

Here’s how the scheme works. You go in to a bank to open a savings account. The bank representative smiles and says pleasant things to you because you brought your money to them. With a big smile the bank representative tells you that you should be happy because you will be earning 1% on your money (if you’re lucky). Trust me when I tell you, the bank representative’s smile gets bigger after you leave. You’ll see why a little later.

You go home feeling pretty good about yourself because you have finally started working on your financial independence. Good for you! It is definitely a start. The question becomes is it what you were really looking for. Don’t get me wrong everyone should have a savings account. But a savings account by nature is not designed to make you money. In fact it won’t save your money either. That’s right you read it correctly. A savings account will not save your money instead it will help slow down your spending.

Naturally you may be asking yourself how can a savings account not save my money? Here’s the answer to this question. A bank pays you 1% interest on your savings account and the government guarantees your money. Meaning that if the bank should go out of business the government insures you that you will get your money back up to $100,000.

A further look reveals just what the bank and the government are guaranteeing you. The bank pays you 1% interest and inflation eats away your money at 3% per year. Inflation simply means that your money will buy you less than what it bought you last year with the same money. So in other words the bank and the government are guaranteeing that you will lose at least 2% of your savings a year. This figure is arrived at by the 3% you are losing to inflation and the 1% interest paid to you by the bank, which means you are only losing 2% a year. That is until you figure in the taxes you have to pay on the 1% interest the bank paid you. However, we won’t talk about the taxes in this scenario.

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