Banking

In this day and age, it's unlikely you don’t already have a bank account, but for those of you who hide all your cash under your mattress, have never opened a bank account, or never use your existing bank account, this section¹ is for you.

Why should you use a bank?#

A bank account is a prerequisite to using other financial tools, which is why it’s the first section in this guide. Before jumping into opening a bank account, let’s talk about why it’s a good idea.

TL;DR: Putting money in a bank is safer than holding cash. It's convenient, and it allows you to save, invest, and use other financial tools.

Security#

Maybe you get robbed. Maybe your house (and all of your money inside of it) catches on fire and burns down. Maybe you hid your cash somewhere, and now you don’t remember where you put it. No matter how you try to protect or store your money, there is probably no better way than a bank. Despite all of the movies about bank robberies, banks are generally extremely secure, both physically and electronically. If a bank is robbed, gets burned down, is destroyed by a natural disaster, etc., the bank has insurance to cover those losses. If the bank fails monetarily and loses all of its money for some reason (e.g. like during the Great Depression when worried customers withdrew all of their money), your money is insured; legitimate banks have Federal Deposit Insurance Corporation (FDIC) insurance. As of 2020, this protects up to $250,000 per depositor.

Convenience#

Having a bank account enables you to access your money virtually anywhere whether it be through an ATM, a brick and mortar bank location, online, or a mobile application. It makes paying your bills and receiving your paycheck so much easier. There’s a reason why almost 95% of U.S. households have a bank (or credit union) account.

Saving#

Say you have $100. Instead of putting it in a bank account, imagine you kept the cash hidden in your mattress. Is that $100 worth the same amount in 10 years? Before answering this question, let's talk about inflation and interest.

Inflation means your money is worth less as time goes on. According to Investopedia, in 1970, a cup of coffee cost 25 cents. In 2019, that same cup of coffee cost $1.59. 25 cents could buy so much more in 1970 than in 2019; thus, 25 cents in 2019 is actually worth less than 25 cents in 1970. This loss of purchasing power is inflation.

Interest² is the cost of borrowing money. When you put your money in the bank, the bank is actually borrowing your money to loan out to other borrowers (don’t worry though - all of your money is still yours, and you can withdraw it anytime). In return for letting them borrow your money, the bank pays you interest. Generally, interest is expressed as a percentage of the amount of money you deposited per year and is called the annual percentage rate (APR). For example, if you deposit $100 into the bank, and the bank has an APR of 1%, then by next year, you will have earned a total of $1 for doing nothing other than depositing your money.

Back to the original question: Is that $100 you hide in your mattress today worth the same amount in 10 years?³ The answer is no because of inflation. Your $100 almost certainly won't be able to buy as much as it can today. If you put that money in a bank account though, you can at least earn some money to offset inflation.

For example, suppose you have $100 in a bank account that pays 1% interest and the rate of inflation per year is 2%. You would have $101 next year, but because of inflation, you would need $102 to buy as much as your original $100. On the other hand, suppose your bank pays 2% interest and the rate of inflation is only 1%. Next year, you would have $102, and you'd be able to buy more than what you could originally buy with your $100 since you have more than $101.

Although interest is great, interest rates are typically pretty low for savings accounts. In 2020, the average interest rate was just 0.09%. If you put $1000 in your savings account, you'd only earn 90 cents in the first year. Interest is better than earning nothing (i.e. saving your money in cash), but to really keep up with inflation, you'll want to invest your money.

Investing#

Instead of earning a meager 0.09% in interest, what if you could earn something like 7% in the first year? That's the historical average annual return for the S&P 500⁴ adjusted for inflation. To put that in perspective, if you invested that $1000 instead of putting it in a savings account, you'd earn $70 instead of 90 cents! In order to have the potential to make those returns, a bank account allows you to easily deposit money into an investment account.

Types of accounts#

Now that we know why having a bank account is important, let's look into what types of accounts we might open at a bank. Banks usually offer multiple account types, but they can generally be classified as one of two options: a checking account or a savings account. You'll probably want one of both.

Checking#

A checking account allows you to do the basics with your money: deposit and withdraw. You'll use this account as a replacement for cash by depositing your income and withdrawing money to pay your bills from here. Money kept here is needed immediately or in the short-term.

Savings#

A savings account allows you to save money - duh. How is this any different from just depositing money into your checking account though? Savings accounts generally have higher interest rates (i.e. earn you more money). Another difference is that checking accounts allow you to make unlimited deposits and withdrawals, but savings accounts can restrict how often you withdraw your money. Money kept here is more long-term.

Choosing a bank#

There are some things to consider when selecting a bank. Some factors are absolute musts and some are a matter of personal preference.

Absolute musts#

FDIC insured#

Your money should absolutely be insured by the FDIC. Check to see if the bank says it's FDIC-insured on their website. If you're not sure, you can also use the FDIC's BankFind to confirm.

Low/No fees#

Some banks have a lot of fees for performing basic functions. Some have account maintenance fees, ATM fees, transfer fees, etc. Do some research to make sure the bank has no fees, reasonable conditions to avoid fees (e.g. maintain a minimum balance), or fees you can avoid by managing your money well (e.g. overdraft fees).

Personal preference#

Online vs. Brick-and-Mortar#

Some banks (e.g. Bank of America, Chase Bank) have both physical locations and online services and others (e.g. Ally Bank, Discover Bank) only exist online. Regardless of what you choose, most banks nowadays have the online services you need to help you bank digitally and on-the-go with your computer or phone.

Because online-only banks don't need to support physical operations, they generally have lower fees and higher interest rates. You might prefer a physical bank if you need to write a lot of checks, like talking to someone IRL, or need to regularly withdraw a significant amount of cash (for whatever legal reason). Be sure to look into a variety of options that suit your preferences.

Location and size#

If you prefer brick-and-mortar banks, you may want to consider where they have branches and ATMs. If you travel a lot, you may prefer a large, national bank or a bank that has locations wherever you frequent. If you don't travel a lot, you might prefer a smaller regional or community bank close to home.

Opening an account#

So now that you know why you should have a bank account, the types of accounts you can open, and how to choose a bank, let's talk about actually taking action and opening an account.

You can choose to open checking or savings accounts in-person or online, but you'll generally need a couple of things to do so:

A valid, government-issued photo ID (e.g. driver's license, passport, military identification, etc.)
Your Social Security number (SSN) or taxpayer identification number (TIN)
Proof of residency (e.g. utility bill, lease, mortgage statement, etc.)

These are just general guidelines, and your bank may ask for additional items not listed here. Check with your bank to figure out what you need to bring if you open an account in-person, or if you're like most people, apply online.

This section is essentially the same as Investopedia's Banking 101 with a few tweaks. This is first of many times I will be referencing Investopedia - it's a fantastic resource for all things finance.↩
To dive a little bit deeper into interest, when we say "interest", we're generally referring to compound interest. If you deposit $100, and the savings interest rate is 1%, then you'll have $101 next year. The year after that, you'll have more than $102 - you'll have $102.01 to be exact. With compound interest, the 1% interest rate is applied to what you originally had ($100) plus whatever you made in interest ($1); you're earning interest on your interest. Though it seems small in this example, compound interest can really add up over time. In contrast, simple interest doesn't get applied to what you made through interest, only the original sum deposited which is called the principal. Using the same example but with simple interest, you'll only earn $1 each year.↩
Did you know 45% of participants in a 2018 national study couldn’t answer a basic question about inflation and interest? Wish we were all taught this stuff in school.↩
We'll talk more about what the heck the S&P 500 is later and how you might go about investing, so don't worry if you don't know what it is.↩