The Personal Finance Basics series continues at Fiscal Fizzle, and today I will be discussing all of the basic account types you will need in order to succeed financially.
Accounts are important to understand because they form the basis of our interaction with money and allow for containerizing and specializing how each portion of your money works for you.
Here’s the breakdown of what I believe are “essential” accounts to have:
“The Wallet” – Your Checking Account
The checking account is at the heart of your financial life. It’s the first account people set up when they become financially independent. In today’s world, it’s practically impossible to get by (conveniently and securely) without the benefit of a checking account.
Checking accounts are not necessarily “containers” as much as they are “pipes” for money to flow through as it moves from one place to another. It’s a hub for transactions – income from paychecks, daily expenses, transfers to other accounts, online bill payments, etc.
“The Stash” – Your Savings Account
The second natural step in any financial account system is the savings account. It’s typically an interest-bearing account with limited ability to withdraw money (a monthly transaction limit) and a direct link to your checking account.
Many people ask why they need a separate account for their savings, instead of keeping extra money in their checking account. If you use a budgeting system that keeps track of money “assignments,” like the envelope system, that may be okay.
For everyone else, keeping savings in a checking account is a huge temptation and rarely properly tracked and accounted for. The end result is that the money gets muddied up with everything else and eventually spent.
Even if correctly accounted for, the availability of money in your checking account is dangerous. Your money needs to be protected from yourself. Set up an automatic barrier by having a second account, preferably at another institution (or at an online bank like ING Direct), where transfers will take at least 1-2 days to complete.
That will give you plenty of time to think about that new TV you have to get.
“Trust Builder” – Your Credit Card
In my humble opinion, the realities of today’s world make credit cards a necessary evil. While most of us understand the dangers of credit card over-use, they are a large component of building up a credit score.
In turn, that score controls a lot of other things in your life, including your interest rates on mortgages and car loans, deposit amounts on everything from cell phones to electrical service, and even your ability to get a job or rent an apartment.
Getting a credit card and using it sparingly will build available credit and a responsible credit history, resulting in better options.
“Money on Steroids” – Your Investment Account
I strongly believe in the importance of having an investment account. Even if it sits empty, or is invested entirely in cash products, the availability of this account gives you the option to learn about means of making money from money that you may not have considered.
Investing has gotten a really bad rap in the last year. Maybe it’s rightfully so, as many portfolios dropped by astounding percentages with the long and painful market decline. But investing for the long term and emotions simply don’t mix.
That’s why I’ve completely ignored everything going on in the market and continue to transfer identical amounts each month and invest in the same products.
I believe in the investment account so much that I use it as my savings account. That’s right – I don’t have any “traditional” savings accounts.
Am I taking on too much risk? Can’t I lose all my money? Oh my gosh, what in the world am I thinking? Actually, the “savings” portion is kept in a cash product, so no – I can’t lose all my money, or any of it for that matter.
An investment account is exactly as safe or risky as you make it. And it can be compartmentalized with various layers of risk for different purposes. That’s why I think it’s the perfect all-in-one savings vehicle.
“The Way Later Fund” – Your Retirement Money
Ahh, the R word. At 25, I’m probably in a unique position in that I’ve thought quite a bit about saving for retirement and how I’m going to get there. In fact, I opened my first retirement account at 18. The sad truth however, is that many younger people could care less about what they’re going to be doing at 65.
Therein lies the problem. The beautiful laws of compound interest tell us that the earlier we start saving, the better. You’ve seen the commercials – every year that goes by or every purchase we make costs us $693,609,095… in retirement money. They’re not kidding.
A 401(k) account, or if unavailable – a personal IRA, is your ticket to retirement savings with some added tax benefits. Unlike a traditional account, most retirement investment gains are shielded from taxes, and you can usually deduct either the deposits (at time of savings) or the withdrawals (at retirement), making it an efficient savings vehicle at tax time.
“Personal Leverage” – Your Loans
A lot of people see loans as just something you have to live with, and they get them the same way. So why have I included them in this list of accounts? Because every loan you take on should be a deliberate choice.
Loans, like credit cards, are simply money you owe to other people, usually for a product or service you received up front with a small cash outlay (deposit). Some loans, like student loans, mortgages, or even car loans can have competitive interest rates, make great financial sense, and have added tax benefits.
Others, like personal loans, payday loans, or loans between family members, can be landmines waiting for a mis-step.
The goal with each loan is to evaluate why you need it, how it can benefit you (or how little it can hurt you), determine if you can afford to pay off the loan now and in the future, and then get it.
These are the basic account types that will get you going on the road to financial success. They will provide all of the “containers” and tools you will need to do almost anything you want with your money.
How you use them is a matter for another post…
Photo by dave_mcmt