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More Than A Little Paranoid
To the average user, the idea of encrypting files probably brings images of spies and conspiracy theorists sitting in dark offices, sweating as a status bar indicating (de)encryption status slowly fills, completing just in time to allow the protagonist time to find a hiding place. But in the real world, there are plenty of reasons to want to encrypt files, including the most obvious one: protecting your files from bad people.
Yes, it would be a stretch to say that failing to encrypt your data is the same as inviting hackers and corrupt governments over to a lunch, but encryption is a powerful security tool. By encrypting your most important files, you can ensure that even if an evil-doer manages to install some sort of data-stealing program onto your PC, or if someone manages to steal your PC, any data they try to get hold of will be more difficult to make useful. If you merely use your PC for sending IMs to family members, then encryption probably isn't needed. But many people keep their entire financial history on their PC.
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File And Folder Based Encryption
The easiest way to encrypt files is to use a program that simply encrypts certain files and folders, and protects them with a password. The best freeware example of this sort of scheme is likely Advanced File Security Basic.
The largest advantage of this form of security is that it is very simple and most programs that provide this sort of encryption, and particularly programs that only deal in this form of encryption, are very easy to understand. Simply choose the files that you wish to encrypt, put in your password, and the file is encrypted. The file will not be able to be read or modified until it is unencrypted by typing the correct password into the encryption software.
The downside to this form of encryption is that files and folders are typically still visible. That means that although the files are inaccessible, they still can be seen by anyone using the system. Therefore, they can be copied from the system. Most encryption programs, even freeware ones, will provide protection against deletion and copying, but obviously this sort of protection won't help if someone is trying to copy or erase an entire hard drive partition.
That said, the simplicity of this form of encryption makes it suitable for most users. If you have a backup of your data, and your data isn't so sensitive that you're concerned about the possibility of someone simply seeing that it exists, this encryption should be all you need.
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For more advanced security, consider a program that allows you to encrypt an entire partition of your hard drive, such as TrueCrypt. Programs like TrueCrypt, besides offering routine file and folder protection, offer the ability to encrypt data on a virtual drive. This concept will be familiar to those of you who've used virtual DVD drives to run programs that normally require a disk in the DVD-ROM. The virtual drive is partitioned off and then encrypted by the program, making it nearly impossible to gain access to the data unless the viritual drive is mounted. This sort of protection also makes your files very resilient to be copied or deleted, because without knowing the password required to unencrypt and mount the drive, nearly any effort to modify the partition is going to fail.
And, if you happen to actually be a spy, then you'll be happy to know that the functionality of programs like TrueCrypt doesn't end there. TrueCrypt can not only create encrypted virtual disks, but it can create encrypted, hidden virtual disks, which are theoretically impossible to detect should you be forced to hand over your password, or your password be discovered. This is a complex process, and it is detailed by TrueCrypt's documentation.
Finally, TrueCrypt and similar programs offer the ability to run an encrypted operating system from the encrypted virtual disk. Encryption of files used by the operating system occurs on the fly. This means that not only are your files protected, but your usage patterns are as well. Temporary files used by most operating systems can unveil how you use your PC, which files are most commonly opened, and which applications you have recently used. With an encrypted OS, none of this information is available.
Most of this functionality is well beyond what the normal user will need, but if you have sensitive data, this protection is about as good as it gets.
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Encryption is a very good example of how free, open-source programs can defeat expensive options created by a single company. Having searched extensively, I can't find any program which can defeat freeware entries such as TrueCrypt. In fact, the encryption program market seems to suffer from the same spectre that plagues the anti-virus and firewall markets. There is a disturbing number of for-pay encryption programs that appear to be poorly constructed, or which attempt to install some form spyware or malware. The only real downside to free programs is that their documentation tends to be less substantial. In this case, the best that money can buy costs nothing at all.