Roughly a quarter of U.S. households are either “unbanked” or “underbanked,” according to the FDIC.
To be unbanked is to be without a checking or savings account at a licensed, FDIC-insured bank. The FDIC defines being underbanked as having a checking or savings account, but still turning to non-bank financial services – such as payday lenders or check-cashing services – at least once in the last year. In many cases, the underbanked turn to payday lenders because they don’t have a credit card or other emergency source of funds.
As banking and currency become increasingly digitized, unbanked and underbanked households are being left behind. Here’s why having financial accounts matters, and how to join the modern banking world to create more wealth and opportunity for yourself.
The Importance of Financial Accounts
It’s hard to build wealth without opening financial accounts. Being underbanked hobbles you financially, leaving you at a disadvantage compared with your peers. Before living one more day with few or no financial accounts, consider these reasons to open them.
1. Ability to Invest
Keeping your funds only in cash leaves you with few options to invest. You can buy real estate with paper cash, but little else.
In order to invest in stocks, bonds, REITs, mutual funds, ETFs, and other paper assets, you need a brokerage account through someone like M1 Finance. Even if you opt for more exotic investments, such as fine art through Masterworks, crowdfunding websites, or hedge funds, you need money in a bank account so you can transfer it electronically.
Wondering why you should invest at all, rather than just save money under your mattress? To illustrate the importance of investing, NYU’s Stern School of Business ran the numbers on what would become of $100 if it were invested in 1928, compared with what would happen to it if left in cash. Invested in U.S. government bonds, that $100 would grown to $7,309.87 by the end of 2017. Invested in stocks tracking the S&P 500, it would have ballooned to an impressive $399,885.98, roughly 55 times higher than if it were invested in bonds.
If that $100 were left in cash, it would still be worth only $100 – except that $100 in 1928 was worth $1,468.46 in today’s dollars. In other words, your money would have shrunk to less than one-fourteenth of its original value.
If you’re not sure why you should invest your money, rather than save it, consider the difference between nearly $400,000 and $100.
2. Ability to Borrow Money Affordably
With no bank accounts or credit, few lenders will even consider you for a loan. That leaves you stuck with the dregs of the lending world – namely, payday lenders and other predatory lenders, whose business models revolve around dangling loans before desperate borrowers who no other lenders will touch. By focusing on desperate borrowers, these lenders get away with charging exorbitant interest rates.
The average annualized interest rate charged by payday lenders is 391%, according to InCharge.org, and that’s if you pay them back within two weeks. But four out of five borrowers don’t repay them in two weeks, sending annualized interest rates even higher to 521%, on average.
For the sake of comparison, credit cards charge 12% to 30% annual interest, and personal loans charge between 10% and 35% – and these are considered extremely high-interest debts in the mainstream banking world.
Don’t limit yourself to predatory lenders. If you know you occasionally need to borrow money for a week or two before payday, try applying for one of these low-interest credit cards rather than turning to payday lenders.
3. Ability to Build Credit
If you want to borrow money to buy a house, car, or just about anything, better credit means cheaper payments and higher loan ratios. Imagine two people who can each afford around $1,500 per month to spend on a mortgage. Emma has excellent credit, and Dan has terrible credit.
Emma gets approved to borrow 97% of the purchase price of a home at a 4% interest rate. She buys a house for $325,000, puts down $10,000 as a down payment, and her monthly principal and interest payment is $1,504 per month.
Dan gets approved to borrow only 80% of the purchase price of his home at an 8% interest rate. He buys a house for $255,000 and has to put down $50,000 of his own money. He borrows the other $205,000, which puts his monthly principal and interest payment at the same amount as Emma’s: $1,504 per month.
To buy a house $70,000 cheaper than Emma’s, Dan had to come up with $40,000 more than Emma for a down payment. His mortgage loan is for $120,000 less than hers, and yet they owe the same monthly payment. In short: credit matters. It directly affects your day-to-day life.
If you have low or no credit, try these tips to rebuild your credit score. One easy way to start is with secured credit cards, but if you don’t like plastic, there are also options to build credit without credit cards. One of the easiest ways is to sign up for Experian Boost. They use the payment history from your cell phone and utility bills to quickly boost your credit score.
4. Ability to Avoid Expensive Check-Cashing Services
Payday lenders and other check-cashing services routinely charge between 1% and 10% of the check amount to cash each check. For a $2,000 paycheck, that could be as high as $200.
Alternatively, if you set up a free checking account – one of our favorites is Chime – you can have your paycheck direct-deposited into your account. No muss, no fuss – just money in your account every payday for free. As a side perk, you won’t have to drive anywhere or talk to anyone; it’s all automated.
5. Ability to Save on Taxes With a Retirement Savings Account
No one likes paying taxes. And by putting money in a retirement account, you can pay less.
If you open an individual retirement account (IRA) through a broker like Betterment, you can contribute up to $6,000 per year for the tax year 2019 and not pay any taxes on it. Citizens over 50 can invest $7,000 and cut their tax bill even further.
Alternatively, if your employer offers a 401(k) or 403(b) account, you can contribute up to $19,000 in 2019, or $25,000 if you’re over 50. All of this comes off your taxable income, as far as the IRS is concerned. You’ll save money on taxes and invest money for your retirement – a win-win.
6. Banks Are Safer Than Mattresses
When you deposit money in a U.S. bank account, the federal government insures up to $250,000 of your money against theft or the bank going out of business. That means that your money is safe in the bank. If the bank gets robbed, for instance, the government reimburses the money.
The same can’t be said for your mattress or floorboards. When people store cash in their homes, it can be stolen, lost, or even physically rot. Your money is safer in a bank than anywhere else, period.
7. Distrust of Banking Fuels Inequality
You’ve heard it muttered a thousand times: “The rich get richer, and the poor get poorer.” But do you know why the rich get richer? Because they invest their money, which requires trust in the financial system.
Take stocks, for example. A 2018 Gallup poll found that only 37% of young adults ages 18 to 34 own any stocks at all. That’s down from the turn of the millennium when over 55% of young adults owned stocks.
The Great Recession proved particularly terrifying for young adults, at least in their attitudes toward stocks. After these investors fled the stock market, stocks did what they always do after a crash: they recovered. But because fewer Americans owned stocks after the crash, the recovery overwhelmingly benefited the wealthy. This disparity in the wealth recovery after the Great Recession has been well-documented by the Federal Reserve, which concluded that stock ownership played an outsized role in the uneven recovery.
Of course, no one says you have to open a bank account, brokerage account, or invest in stocks. Just know that if you don’t, you continue to sit on the sidelines while the wealthy watch their investments multiply and make them even richer.
4 Financial Accounts Everyone Should Have
Not everyone needs to invest in hedge funds or REITs. But you should have, at the very minimum, these four financial accounts to help you build wealth and avoid usurious lender fees.
1. Checking Account
Without a checking account, it’s hard to have any other financial accounts. A checking account doesn’t have to cost money; check out this overview of the best free checking accounts available today. They each come with a debit card to help you shop online and carry less cash in your wallet, again improving the safety of your money.
After opening a free account, use it to set up direct deposit for your paychecks, saving you a trip to the check-cashing store and their high fees. You can then use your checking account to help you open a credit card and start improving your credit.
2. Savings Account
When you open a checking account, talk to the bank about simultaneously opening a free savings account. Savings accounts let you move money out of sight and out of mind, helping you build an emergency fund, stop relying on payday loans when you’re in a pinch, and stop living paycheck to paycheck. Having even $1,000 in the bank is reassuring and lowers your financial stress.
If you’re not sure how to save more money, try these automatic savings account apps to move small amounts of money into savings for you without you even having to think about it.
Pro Tip: Don’t settle for a savings account that offers less than 1% APY. Check out some of the best high-yield savings accounts, many of which offer well above 2% APY.
3. Brokerage Account
A brokerage account allows you to invest in stocks, bonds, and other paper assets. Everyone needs a brokerage account, even if they also have a retirement account (more on those momentarily).
I use Charles Schwab for my brokerage account, but Vanguard offers excellent brokerage accounts as well. They’re free to open, which usually takes less than five minutes, and both offer a range of commission-free fund options.
You can also choose a robo-advisor like Betterment. They have features like automatic tax-loss harvesting, which will boost your after-tax returns. They also automatically rebalance your portfolio when market conditions change.
If you’re new to investing in stocks, try starting with index funds that follow major stock indexes. You don’t need to worry about picking stocks; the funds simply own whatever stocks are trading in that stock index. You can begin with just three: one index fund for U.S. large-cap stocks, one for U.S. small-cap stocks, and one for international large-cap stocks. You can get fancy later; right now, the important thing is just to get started.
Every American adult should have an IRA. Like brokerage accounts, IRAs are quick and easy to open. In fact, they’re handled through your brokerage, so when you open a brokerage account, you can open an IRA at the same time.
As outlined above, the money you invest in an IRA is deducted from your taxable income when Uncle Sam comes calling for his cut of your paycheck. If you’d rather pay taxes on the money now and avoid taxes later when you retire, you can open a Roth IRA instead of a traditional IRA. Roth IRAs offer more flexibility as they can be used to fund more than just your retirement. You can use a Roth IRA to fund your or your children’s college tuition, for example. You can also use retirement accounts to fund a down payment on a house.
Open an IRA or Roth IRA, start contributing, and if you want to use the money later for other major life purchases like a home or college education, so be it. After taking the first step of opening the account, you’ll find yourself increasingly comfortable using it.
No one wants to be left behind while the rich get richer. But if you shun mainstream banking, it’s hard not to be left behind.
You don’t need to become a financial wizard overnight – or at all, for that matter. What you do need are the four basic accounts outlined above, which only require a couple of phone calls or online visits to set up. It may take a leap of faith on your part if you have no experience with banks, but opening accounts to save and invest your money is the first step on the road to wealth.
Are you unbanked or underbanked? What has been keeping you from opening financial accounts?