Part 1: Personal Finance 101 — Banking, Credit Score, Savings
To me, personal finance is about being able to live in a way that is meaningful to you without being constantly worried about money. This article is hopefully a living guide to help you navigate the personal finance waters.
Note: this article is based on the US system with additional information for international students in the US. This article is also targeted at 20-somethings but applicable to all.
Also: I try my best to acknowledge privilege throughout the series, but do make note of how various levels of privilege allow people to follow various amounts of this guide.
Parts of the series (these are all equally important)
Checking and savings accounts
When you open up a bank account, you’ll usually get a checking and savings account. A checking account is for daily spending (you gain no interest on money in that account, but you can move money in and out unlimitedly). A savings account usually has a limit on how many times you can withdraw money each month (i.e. 5) but you earn interest on money in that account.
In 2021, interest rates are near 0 (i.e. Bank of America savings is 0.01%) which means you earn almost no money by keeping money in a savings account. Some people will recommend opening up a high yield savings account with an online bank, this was good advice in years past and perhaps will be in a few years time, but right now, the highest yield savings account only has a 0.6% interest rate (so saving $100 in a year will pay you 60¢ of interest in a year) so it won’t make much of a difference (but keep this in mind as interest rates rise over the next few years).
So the flow is usually your paychecks will go to your checking account, keep some emergency money in your savings account (these accounts are FDIC insured up to $250k meaning even if the bank goes under, your money is still safe), but you’ll actually gain wealth through investing which we cover in Part 2.
Debit cards and credit cards
Getting a credit card is often the easiest way for young people to build credit. Often, spending within your limits on a credit card is superior to spending within your limits on a debit card because 1) your credit card has many protections (i.e. if someone steals your credit card and uses it, the bank can claw it back for you but if someone uses your debit card, the money is often gone/ a pain to get back) and most importantly 2) using your credit card builds your credit score.
A truism of personal finance (and perhaps of life) is that you should be diligent about the big things, and not sweat the little stuff. Deciding on one 50¢ boba topping or two 50¢ boba toppings is the little stuff, having a good credit score is one of the big things.
Credit scores are calculated using a mysterious formula that is impacted by how well you have paid back credit in the past, how much credit you use, your credit mix, how frequently you ask for more credit, and how long your credit history is. 7 years is considered a good credit history length. Even if you were to start making $1m a year tomorrow, you can’t suddenly get to a great credit score unless you thought about it many many years back.
And why does a good credit score matter? Well, let’s say you want to take out a mortgage for $150k. If you have excellent credit, you’ll pay say a $3.2% interest rate while if you have poor credit, you’ll pay $4.8% which is equal to paying $50k more over the lifetime of the mortgage. Or let’s say you want to rent an apartment, your potential landlord will check your credit score and they can reject you if they don’t like it.
Having a credit card and paying it back in full every month is an effective way to start building your credit history.
Pro tip: set up auto payment for your monthly credit card bill in case you forget to manually pay off the balance and disable overdraft protection (if you spend money your account doesn’t have, your bank defaults to not telling you but “helping you out” by covering your bill and charging you high overdraft protection fees).
If you’re getting your first credit card and wondering “wait, I need good credit to get a credit card but a credit card to build credit, wtf?!” you should apply for a starter credit card. Bank of America has starter credit cards and here’s a list of others. International students, do this right away as you’re setting up your US accounts. After a couple years of credit history, switch to a credit card with nicer benefits like these.
Two things: 1) having an emergency fund is critical and 2) as a young person, you probably underestimate how expensive the big expenses in life are.
This is a fund that you can access at all times (I don’t invest mine), in case of emergencies such as job loss, health, or whenever life gets you down (i.e. car crash, broken laptop, phone in toilet, etc.) How much you should save in your emergency fund depends on many factors:
- The less stable your income is, the more you may need in a dedicated emergency fund
- The less stable your household is (i.e. one income vs. two), the more you may need to save
- The less stable your health is, the more you may need to save
I consider having an emergency fund, getting rid of debt, and investing as three equally important foundations of personal finance well-being.
Saving for large expenses
As a young person myself, it takes a lot for me to wrap my mind around how expensive the big expenses of life are. In college, I thought saving for a $200 concert was crazy. But imagine trying to buy a (small shoe closet) in SF that costs $800 000.
You may be able to save $200 for a concert this summer, but it’s going to take quite a bit more long-term planning to save $160 000 for a 20% downpayment on a $800 000 house.
That’s why it’s good to have savings/investing accounts for big expenses. Work backwards from when you’ll need the money. Some examples (from largest to smallest) may include:
- $100k downpayment (20% down on a $500k house), if you save $20k a year, in 5 years you will have enough
- The average wedding in the US costs $30k. So if you want to get married at 30, and are currently 25, and you and your SO will split the cost, you need to save $3k annually for the next 5 years
- Let’s say you want to go to Europe next year and the average 2-week vacation is $4k. You’ll need to save $334 every month for the next 12 months to afford that
- If you think you’ll need $900 for Christmas gifts, then you’ll need to save $75 a month
The purpose of this section is to say, for big expenses, planning ahead is useful because the numbers may blindside you otherwise.
In part 2 of the series, I write about investing (which order to fund which accounts, and how to think about portfolio allocation). Read part 2 here.
In part 3 of this series, I write about methods to pay down debt, budgeting methods, and how to be thoughtful about giving. Read part 3 here.
Hope this was useful, and remember, don’t let perfection be the enemy of the good, so just get started!
Disclaimer: The information provided, opinions expressed, resources cited, and service providers mentioned in this post are not intended as, and should not be construed as, financial, tax, or legal advice. I am not an attorney, tax preparer, accountant, or financial advisor, and I do not hold myself out to be any of those professionals. The contents of this post are not a substitute for legal, tax, and financial advice from a professional who is aware of the specific facts and circumstances of your individual situation. I expressly recommend you seek advice from a professional on these matters. I do not sponsor, endorse, verify, or warrant the accuracy of the information found at external sites or subsequent links. The opinions expressed in this post are solely my personal opinions and are not connected in any way to any past, present, or future employer.