The sheer number of financial accounts today is incredible. It can be hard to decipher the alphabet soup of financial jargon to figure out which accounts are right for you. In this article, we demystify these financial accounts and in what order you should open the accounts. Unlike other financial blogs, we are not paid for promoting any of the accounts listed below, but instead have tried these accounts ourselves, and did the research to find the best ones. Open these accounts to start building wealth today:
1. Checking Account
This is the account that will fund your other financial accounts, so you need to set this up today. If you already have one, feel free to skip over this step! If you don’t have a checking account, you can open one at any of the major national banks or your local credit union. Applications take less than 15 minutes and you can do it all online.
2. Emergency Fund:
Life happens and you need to be prepared. Some of your investments might be volatile (high risk, but high return!), so you need to keep a buffer of cash in case of an emergency. This will allow you to stay invested in your other assets, and reap the long-term benefits of compounded interest.
For an emergency fund, the usual recommendation is 6-months worth of expenses. But who knows exactly what 6 months worth of expenses looks like? Here’s our quick and easy estimate to get your monthly expenses: take your monthly rent and multiply it by 2. Use that to get started, if you want a more detailed calculation of expenses, sign up for Mint and track your expenses over the next month, then adjust your emergency fund as neede.
Where should you keep your emergency fund? We’d recommend keeping it in a savings account. Keeping your emergency fund in a savings account gives you two benefits over a checking account: 1.) a higher interest rate, and 2.) keeps your savings separate so you don’t accidentally dip into emergency fund when paying day-to-day expenses.
3. Retirement Accounts:
Now that you have a checking account and emergency savings fund, you’re ready to start investing for the future. The first accounts to fund are retirement accounts. Why? Because the government chips in to your retirement accounts by giving you tax savings. Think about different investment accounts as buckets, and your income as the “water” to fill those buckets. You want to fill the buckets that give you the highest returns first, before filling other buckets. Retirement accounts give you special tax benefits, that other investment accounts don’t so make sure to fill these accounts first.
Retirement accounts can be confusing, here’s a quick overview of the basic types of accounts:
- 401(k): Offered by your company and funded by payroll contributions.
- IRA: You manage this on your own and fund through contributions from your checking account
If you have a 401(k) offered at work:
- Take advantage of it! ⅓ of employees don’t have access to a 401(k). Some employers match 401(k) contributions, and if your company does contribute to get the maximum benefit.
I don’t have a 401(k) at work:
- Contribute to an IRA. You can contribute $6,000 to an IRA or $7,000, if you’re 50 years and older.
I fund my 401(k) completely and I still have savings left over:
- The 401(k) savings limit is $20,500 in 2022. If you still have money left over after maxing your 401(k) contributions, you can contribute even more by opening an IRA and putting more contributions in there.
If you’ve made it this far, you’re doing much better than most. Around 55% of Americans don’t have enough saved for retirement (link) and 56% of Americans don’t have enough in emergency savings to cover a $1,000 expense (link).
4. Brokerage Account:
Alright, so to take things to the next level, you can open up a brokerage account. This account will allow you to invest in assets such as stocks or bonds. While a brokerage account doesn’t have tax advantages like retirement accounts, they allow you to get a high rate of return on your money. Over last 100 years, the stock market had a return of 10.9% (source). Assuming you invest $1,000 today, here’s what that amount of money will look like overtime as it grows:
When it comes to investing in the stock market, we recommend sticking with index funds. Index funds hold many stocks, which reduces volatility and gives you the benefits of diversification. Diversification is important, because it ensures that if one stock does very poorly, your entire portfolio is still in good shape, because you hold many other stocks. For example, a good index fund like VTI hold 4,136 stocks. Also, if one stock does really well, you still benefit, because you hold that stock as well.
In terms of companies you can open a brokerage account with, there are many you can choose from. The most important feature of a brokerage account is that trades are free. Here are two brokerages we like:
Interactive Brokers:
- Main Advantage: Fractional shares. If you want to buy an index fund that costs say $200, but are contributing $100 every month, you have to wait until you have enough money to buy a share. With fractional shares, you can buy half a share right away.
Bank of America:
- Main Advantage: Preferred Rewards. The more assets you have in your brokerage account with Bank of America, the better their credit card rewards are:
- $20,000-50,000: Get 25% more credit card rewards
- $50,000-$100,000: Get 50% more credit card rewards
- $100,000+—Get 75% more credit card rewards
For more information about what to invest in, check out our deep dive on investment products you can buy in your brokerage account.
Bonus! Keeping track of accounts:
To keep track of all your new accounts, we recommended using Mint. It will show you your expenses and how your net worth is growing over time.
That’s it! Once you have these four accounts open, you are on your way to building lasting wealth and financial independence. Think of this as laying the foundation for your very own FinTrek. Once you have these setup, you can move on to more advanced investment topics like alternative investments or real estate.
Happy trekking!
