Banking 101: A Beginner’s Guide
When you start your financial journey after high school or college, retirement might seem ages away. But the choices you make in your early years play a crucial role in your future success.
As such, it’s critical to establish banking literacy so that you have a clear sense of what to do and where to put your money. This starts with understanding how banking works, and the different types of options that are available to you as a customer.
This post provides a complete overview of banking, including the different types of banks and financial products on the market, and tips for getting started.
How to Open a Bank Account
- Round up your assets
- Get your identification together
- Pick a bank
- Shop around for the best provider
- Open a bank account
1. Round up your assets
First, take stock of your financial assets. Collect all of your cash and other savings and add up how much you have.
You should also look around for any savings bonds that may be sitting around from when you were growing up. Oftentimes, relatives give savings bonds as gifts, and these bonds tend to mature when you’re in your early 20s and 30s.
If your savings bonds have matured you may be able to cash them out. But remember that you most likely owe taxes on the earnings.
2. Get your identification together
To open a bank account, you’ll need proof of identification. You’ll need a state photo ID, passport, birth certificate, or Social Security card. Some banks require you to have more than one type of identification.
In addition, you need to provide your physical address, date of birth, and phone number. You may even need to provide examples of physical mail to verify your home address, such as your phone or cable bill.
3. Pick a bank
Next comes the tricky part — determining the type of financial institution to manage your money.
Young financial consumers are often surprised to learn how many types of banks there are. Here are a few of the most common types of banks to pick from.
A retail bank is a company that primarily issues financial services to consumers. For example, Chase, Bank of America, and Wells Fargo are three popular retail banks in the United States.
Chances are your town or city has some smaller local banks to choose from as well.
Retail banks are open to the general public, meaning as long as you have basic identification, you should be able to open an account. Some banks may also require you to fund your account immediately at the time of opening, so the account does not sit idle without anything in it.
In addition, retail banks sometimes have minimum balance requirements and may charge fees if your account falls below a certain threshold.
An online-only bank is a financial institution that exists solely online — meaning they don’t have any brick and mortar banks.
Typically, customers engage with online banking services through a mobile app or on a website browser.
Since online banks don’t usually have high operating costs, they are able to provide customers with competitive interest rates on online savings accounts that most retail banks can’t produce. There are a few exceptions though, and some online banks do have a few branch locations for customers.
- Check out our post about the Best Online Banks for 2021.
A credit union is similar to a retail bank in that it offers the same type of financial products like checking and saving accounts (more on these below).
However, a credit union is fundamentally different from a retail bank. Retail banks are for-profit organizations, meaning they exist to make shareholders money. This is typically accomplished through charging fees and interest on loans and mortgages.
Credit unions, on the other hand, are not-for-profit organizations. Also known as cooperative banks, credit unions exist solely for the benefit of their members. As a result, profits flow back to members in the form of higher interest rates, lower fees, and better rates for loans.
Can anyone join a credit union?
Credit unions often have strict membership rules and are not generally open to the public.
To sign up for one, you have to qualify through an affiliate association, such as a school, community groups, church groups, or through employers.
Explore your network to see if you belong to a group that offers access to a credit union. If so, you may be able to benefit from higher rates than retail banks offer.
Brokerage & crypto accounts
To be clear, brokerage accounts and crypto accounts are not bank accounts. However, there is a fair amount of overlap.
To open your brokerage and crypto accounts, you need to transfer funds from your primary checking or savings account (usually via an ACH transfer). You can also withdraw funds from your brokerage and crypto accounts and send them to your bank accounts.
4. Shop around for the best provider
Once you determine the type of bank that you need, avoid rushing to sign up before you shop around.
Even if you are looking for a credit union, it pays to consider all of your options. For example, you may be eligible for more than one credit union if you belong to multiple associations.
Here are some things to look for when opening a bank account.
Accessibility is important to consider when selecting a retail bank. For example, look into the total number of ATM locations that the bank supports. If the bank has a small number of nationwide ATMs, look into whether the bank will penalize you for accessing money through third-party providers.
This is a big issue when working with small banks that only have a local presence. However, one option that you can consider is opening an account with a local bank and a separate account from a national provider like Bank of America that you can use when traveling.
In addition to ATM fees, you should also look into other types of fees that banks charge. Financial providers are notorious for charging account maintenance fees, annual fees, and overdraft fees to name just a few examples. Also, if you tend to overdraft your account, you might want to look for a bank that offers overdraft protection at no added cost.
The level of customer support that each bank offers varies widely. For example, some financial providers go above and beyond to offer 24/7 customer support over the phone and live chat. Other banks might not offer customer support after hours or on weekends.
When you have an important banking matter, such as a lost debit card or suspicious transaction, the last thing you want to do is sit on hold for an hour trying to contact support.
If you are the type of person that tends to get frustrated when dealing with customer support agents on the phone, then you might prefer a traditional banking experience (wherein you can pop into a local branch and get help from someone in person).
Mobile app quality
Bank apps have come a long way. These days, you can conduct almost any banking transaction from your phone. With that said, make sure that the bank you are signing up for has a well-rated mobile banking app. Not all providers offer great mobile experiences, and so it definitely pays to research this ahead of time.
Generally speaking, the most established national and online banks have robust mobile apps, so that’s good news.
5. Open a bank account
At this point, your money and paperwork are in order and you have identified the type of bank you want to work with. You might even have a shortlist of banks that you are considering signing up for.
The next step is to drill down into the types of accounts that you want to open. This step helps you further narrow down the selection process.
Investing vs. saving
Ultimately, the strategy you choose depends on your unique financial situation. However, you should consider building a strategy that involves saving and investing.
The difference between saving and investing comes down to risk. When you deposit money into a federally-insured savings account, you can’t lose money unless you take it out of the account. You can also generate small returns over time thanks to interest.
One thing to keep in mind though is that interest rates are almost always less than the rate of inflation. As a result, you can technically lose money over time due to inflation.
Investing your money in places like the stock market or real estate involves taking on higher risk. The stock market is highly volatile, meaning you could lose your money if you make the wrong investment. At the same time, you could make a lot more money than you would by putting your money into a savings account.
That said, savings and investing aren’t exclusive. You can and probably should open savings accounts and investment accounts for a mix of stability and growth.
Why Do You Need a Bank Account?
Let’s face it: the banking industry has changed dramatically in the past two decades. Disruption and innovation are happening everywhere, as tech-savvy millennials increasingly consume new, digital methods of managing and transferring money.
As a result, many young people are wondering whether a regular savings account is even needed anymore, or whether it’s going the way of the dinosaur.
That said, while the financial world is changing, bank accounts remain a critical service for consumers — and they’re not going away any time soon.
Here are some of the top reasons that you need a bank account.
1. Protect your money
When your money is deposited into a bank, you have $250,000 worth of protection from the Federal Deposit Insurance Corporation (FDIC) or National Credit Union Administration (NCUA).
Stocks, bonds, and other types of securities are protected by the Securities Investor Protection Corporation (SPIC) for up to $500,000. Brokerage accounts have a $250,000 protection limit.
Not all online payment services come with federal protection. For example, PayPal is not FDIC insured.
Simply put, your money is much safer when it’s stored in a bank than it is in your closet.
2. Make more over time
Interest rates for savings accounts are lower than they used to be, but still, you can receive monthly kickbacks from banks through earned interest.
What is interest in banking?
Interest is a recurring payment made from a deposit-taking financial company to a customer, in exchange for keeping money in the bank. Interest rates tend to vary depending on the type of bank you work with and the type of account you have.
Interest primarily applies to deposit accounts from banks, which include some checking accounts, and almost all savings accounts and certificates of deposit (more on that later).
3. Build trust with lenders
Banking relationships won’t directly boost your credit score, however, lenders often use your banking history to get a sense of whether you’re a responsible financial consumer.
For example, if you decide to buy a house, a mortgage lender will most likely ask for several months’ worth of bank statements. Without this information, it can be hard to secure a loan.
Furthermore, if you cannot balance your bank account, then it’s probably an indication that you should not be taking on a mortgage loan.
As you can see, having a bank account is important for many reasons. Whether you’re looking to pay for daily items like groceries with a debit card, or if you want to save up money for a big life event, having a bank account makes things a lot easier.
Types of bank accounts to consider
Checking accounts are used for everyday transactions. They are not bound by Regulation D, making them more flexible than savings accounts and useful for daily transactions like groceries, gas, and utility payments. You can obtain a checking account through a retail bank, online bank, or credit union. If you take the online route, your account is considered an online checking account.
Traditional savings account
Retail banks and credit unions offer traditional savings accounts, which are safe places for storing money.
Savings accounts are typically linked to checking accounts and come with transaction limits. Under Federal Reserve Regulation D, you are only allowed to make six withdrawals or transfers per month from a savings account.
High yield savings account (HYSA)
Many online banks offer HYSAs, which are savings accounts with much higher interest rates than those offered by traditional banks. For example, at the time of writing, Ally’s HYSA pays 0.50% APY on savings deposits, compared to the national average of 0.05%.
HYSAs are also bound by Regulation D, so if you exceed the six transaction threshold the bank may reduce your interest rate. Another thing to consider is that some online banks don’t offer ATM access. So to access your money, you must link your HYSA with another account.
Money market account
Money market accounts are deposit accounts that come with higher interest rates than traditional checking or savings accounts.
Money markets offer flexibility and stronger returns, but they tend to have higher minimum account balances, meaning you need to have a certain amount of money in the account at all times to avoid monthly fees. Some also have monthly maintenance fees.
Certificates of deposit (CDs)
One of the downsides about savings accounts is they come with variable interest rates, meaning the rate can rise and fall depending on the state of the economy and the bank’s policies.
To protect against price fluctuations, consumers sometimes choose to put their money into CDs, which let you lock your money into a fixed interest rate for a set period of time. CDs can be as short as one month, or as long as 10 years or more.
The tradeoff is that you can’t touch your money while it’s in a CD without risking early withdrawal penalties that could wipe out any interest gains. Before you open a CD, make sure that you’re comfortable not accessing those funds for the full term limit.
While investment accounts aren’t bank accounts, it’s important to understand what they are and why you should have one.
The goal of having an investment account is to grow your money through investing in stocks, bonds, and other equities.
There are two ways to invest through a brokerage firm. You can open a brokerage account, or you can put money into a tax-advantaged individual retirement account (IRA).
A brokerage account is a flexible way to invest in the stock market. It lets you invest in a variety of assets like stocks, bonds, index funds, mutual funds, and exchange-traded funds, without restricting when you can access your money. That means you can move money in and out of your account without facing any penalties.
Just keep in mind that when you invest in a brokerage account, you’ll pay taxes on capital gains and dividend distributions.
Investing in an IRA is similar to using a brokerage account, in that the account provides access to a variety of investment opportunities. The main difference is that with an IRA, you can’t touch your money until the retirement age of 59 ½.
If you need to access your funds before you retire, you may face penalties from your provider or the IRS.
Here are the three most common types of IRAs:
- Traditional IRA: This type of account lets you delay taxes until retirement age, for tax-deferred growth.
- Roth IRA: With a Roth IRA, you can pay taxes upfront for tax-free growth — meaning you won’t have to pay taxes when you withdraw the money at retirement age.
Traditional and Roth IRAs come with annual contribution limits, which restrict how much you can deposit during the course of a year. For tax year 2021, the contribution limit is $6,000.
- Simplified Employee Pension (SEP) IRA: This type of IRA is for self-employed individuals. For example, if you’re an independent contractor funding your own retirement, you may benefit from a SEP IRA. It comes with a much higher contribution limit of $58,000 per person.
As you can see, there are many types of accounts to choose from. It all comes down to finding the banking provider that best aligns with your needs and major life goals.
Next, let’s go over some of the most commonly asked banking questions that you may be wondering about.
Frequently Asked Questions
What is APY and how is it different from APR?
APY stands for annual percentage yield and refers to monthly compounding interest that the bank pays you on deposits. On the other hand, annual percentage return (APR) refers to a simple interest rate over the course of a year. Typically, loans and credit card balances come with APR fees that you have to pay.
The bank denied me an account. Now what?
Just because a bank denied you doesn’t mean it’s the end of the road. Your next step should be to determine why.
If possible, arrange a sit down meeting with a representative from the bank and ask why you didn’t. For example, maybe you didn’t submit the correct forms or maybe you have outstanding debts that are tarnishing your credit score.
With that in mind, it’s a good idea to request a copy of your credit report and look for any possible errors indicating you are an irresponsible customer. For example, if you are a victim of identity theft because someone opened a fraudulent account in your name, this could prevent you from securing future accounts and loans.
If all else fails, look for a provider that offers a second chance checking account, which is designed for those who are looking to establish or rebuild their credit score.
What is a credit score?
A credit score is a report that estimates your ability to pay back a loan as a borrower. A credit score ranges from 300 (bad) or below to 850 (excellent).
To protect your credit score, always pay your balances off at the end of each month. This keeps your credit utilization — or total percentage of used credit — in check. You should also keep a close watch on your score and monitor for unexpected movement.
A strong credit score can get you better rates when applying for any type of loan. So it pays to maintain a healthy score, especially if you are considering buying a home.
Do I need an emergency fund?
The short answer is yes — you absolutely need an emergency fund.
Start putting money away into a savings account from either an online bank or a traditional bank, so that you can cover up to six months of daily expenses in the event of an emergency.
Having an emergency fund protects you against sudden job loss or illness, and can prevent you from going into debt if you need to cover unexpected repairs on your house or car.
The Bottom Line
There is a lot to consider with banking, and it’s easy to feel overwhelmed — especially if this is your first time opening a bank account. You can spend a lifetime studying personal finance and still find things to learn. So don’t feel bad if you’re new to the game. Keep on educating yourself and improving your financial literacy.
Now that you know the basics of banking, form your game plan to set yourself up for long-term success. Remember that the decisions you make today are directly connected to your future prosperity. If you want to achieve wealth and retire early, now is the time to start!