What is a savings circle and how can it help your money goals?

Setting up a collective fund with trusted friends or family can lead to strong financial habits, experts say

A savings circle can keep family members accountable and also help them reach financial goals, such as having the seed money to set up a small business. Getty

A breezy January morning made the 1°C temperature feel even chillier. But it was an important day for the young man: he was about to face his entire family to ask for a loan to seed his new business idea.

He had contributed to the family’s savings circle, but he was asking for a withdrawal this time.

A savings circle is a group of family members or friends who regularly contribute to a collective fund. Members gain access to a share of the proceeds on a rotating basis or as needs arise.

A savings circle can also be called a money pool. Or flip the benefit, and it’s known as a lending circle. The practice carries many names worldwide — including tanda, sou-sou and tontine.

It can be an informal gathering with regular monthly contributions and one disbursement or one individual’s request for funding approved by the group. Some savings circles predetermine automatic withdrawals for each member in a particular order.

Berry Gordy was 29 that cold Detroit day in 1959 when he faced the family’s pointed questions regarding a $1,000 loan from the Ber-Berry Co-op — named after his parents, Bertha and Berry. After a lengthy discussion, the group voted to give him $800.

And with that seed money, Motown Records was born.

David Ellis, a digital media curator at the Motown Museum in Detroit, says Mr Gordy’s parents created the savings effort to help seed family business ideas. Each family member, including spouses, contributed $10 a month to the fund.

“The funniest part … is the interest that Berry Gordy had to pay. They were family, but they were still very professional people,” Mr Ellis adds.

Unlike many traditional family and friends savings circles, Mr Gordy had to repay the loan and would be charged 6 per cent interest if he didn’t pay off the note within one year.

However, repayment wasn’t a problem. Motown Records became a music institution and Mr Gordy sold the label for $61 million in 1988. A 50 per cent share of the Motown song catalogue garnered an additional $132m for Mr Gordy in 1997.

After finishing graduate school, Fonta Gilliam was working as a US foreign service officer in South Korea, “stamping visas at the consulate”.

“This lady walks up to my window … wanting to immigrate to the United States to start a business. She was going to start a dry cleaner if I remember correctly.”

The woman, a street vendor, had a six-figure sum in a savings account.

“I remember thinking, ‘OK, this is fraud,’” Ms Gilliam says.

But the woman related how she had participated for years in a savings circle with friends in her neighbourhood, “and it was finally her turn” to make a withdrawal.

“I learnt how a lot of people around the world are using informal saving and lending traditions — sou-sous, tandas — as a way to build wealth outside of the banking system,” she adds.

Ms Gilliam discovered that the social savings circles in these underbanked and underserved communities often have a low default rate. The social factor is key. “People are more likely to keep strong financial habits when their peers keep them accountable,” she says.

If you are looking to start your own savings circle, enlist trusted friends and family. Emphasis on “trusted”.

Your group will need to determine the amount and frequency of deposits and the order of individual withdrawals.

For example, if 12 members put in $100 per month and distributions occur monthly on a rotating basis for one year, who gets the first $1,200?

It’s an important consideration because early withdrawals are essentially zero-interest loans, while later distributions are effectively interest-free savings plans.

A few savings circle apps have been developed in recent years, such as Esusu Savings and MyMAF, which manages lending circles set up through Mission Asset Fund in the US.

And later this month, Ms Gilliam and a team of FinTech developers in Washington are set to release a savings circle and social banking mobile app called Wellthi.

While group savings goals will be shared, funds in Wellthi will be tied to individual digital wallets, linked to a payment card and never co-mingled.

And it all began with that chance encounter when the Korean woman was looking to start a business in the US.

“It really kind of changed my life, to be honest. And I had almost denied that woman a visa,” Ms Gilliam says.