How to Build Your Financial Foundation

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New Construction FoundationPouring the foundation is the first step in building a new house. Ensuring it is level, stable, and on solid ground is more important than any subsequent step in the building process. Your finances are no different. Setting up a stable financial foundation will be paramount in ensuring your finances are in good shape.

Fortunately, the steps towards establishing a sound financial foundation are very easy. The hard part is knowing what those steps are and, unfortunately, those aren’t taught in many schools. I like to think of my financial foundation as the network of financial accounts onto which all my life’s decisions are made.

A good way to think of your financial foundation is to draw a financial network map. A financial network map is simply a picture of all of your accounts and how they are related. If you are starting from nothing (no checking account, no savings account, no credit card, etc.), your map is blank. If you have a couple accounts, draw the map and we can start from there.

Your foundation starts with three different financial accounts:

  • Checking account – For short term expenses, paid monthly or less frequently. Your checking account will pay things like your car or student loans, your rent, etc.
  • Savings account – For longer term expenses and as a holding area until you decide where to put it, such as in retirement, saving for a vacation, or an emergency fund.
  • Credit or debit card (optional) – For daily expenses like food, gas, etc.

This post is part of Bargaineering’s 2010 New Graduate Guide series where I’ll share my insights and offer my financial guidance to the graduate class of 2010. This post is part of day 1, establishing your financial foundation.

Checking Account

A checking account will be the center hub of your map. Your employer will direct deposit your paycheck there and you will pay your bills from that account. Checking accounts earn no interest, which stinks, but their purpose is merely to be a holding tank for your cash before you decide what to do with it.

There are two important factors I look for in a checking account:

  • Convenient Access to branches and ATMs: Convenience is key and that’s why I use a large megabank like Bank of America, they have ATMs everywhere. Find one that convenient for you and you’ll be much happier.
  • Fees: Be aware of any account fees, such as a service fee if your balance is under a certain amount. You should find one with no minimum account balance (Bank of America’s MyAccess Checking has no minimum balance if the account is opened online). If you can’t, try a credit union as they’re usually friendlier in this regard. Never pay for a checking account.

If you need to open a checking account, look for bank deals that will give you $100 or $150 for a new account. Also, don’t have more than one checking account, it’s unnecessary.

Savings Account

If your checking account is for daily activity, your savings account is your default holding spot for money you might need in the next month or two. You will earn a little bit of interest but it won’t be much, especially if you’re at a megabank with brick and mortar locations. The best interest rates will be at high yield savings accounts of online banks. Megabanks simply can’t compete.

If you’re uncomfortable with online banks, consider opening a savings account where you have your checking account. Bank of America has a savings account that pays a near meaningless 0.10% APY (as of May 5, 2010), which is better than 0% but far worse than online banks.

Credit Card

This piece of the financial foundation is optional, especially if you’re worried about your credit discipline. A credit card has several benefits. First, it helps you build a good credit history, which is becoming the most important number in your financial life. Credit cards also give you a short grace period on purchases, which can help your budget. Finally, they come with purchase and fraud protections you don’t get from cash. You can get a debit card, which offers similar fraud protections, as an alternative to credit and many people use debit or cash online.

Which credit card should you use? It depends on your purchasing history. The best credit cards are the ones that offer rewards or features you will be able to take advantage of. Here’s an article that may help you pick the best credit card for you.

Seems too simple right? The basics often are. Start with this and add to it as you need to. You have too many other things competing for your attention and concentration right after graduation. Spend a couple hours to set this up and then revisit in a few months when things have calmed down. Then, when you aren’t rushing to figure things out, you can work on adding to your foundation.

(Photo: concrete_forms)

{ 13 comments, please add your thoughts now! }

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13 Responses to “How to Build Your Financial Foundation”

  1. Shirley says:

    Great post, Jim!
    It’s info that is almost never too early to get started with. I have grandkids still in high school who can use this to pave their way toward adulthood.

    • I agree that this would be perfect for children, especially those in high school. There are not many high school’s that actually offer classes that can help students understand basic finances. Helping them understand from an early age could help make it easier for them once they enter the real world.

  2. cubiclegeoff says:

    I wonder if the “savings account” should be split in two: emergency savings and long-term savings. Emergency savings would be for those times that you need it unexpectedly, long-term savings is for things you are thinking about a month, several months, or years in the future.

  3. Mike says:

    Hi Jim,

    I think it’s good to teach concepts like Financial Foundations because it gives people something to think about.

    Also, having the savings separate from checking is a great idea as it allows you to focus on the habit of saving money. If things are all tied together, it may become complicated – as in savings never happening.

    Nice post.


  4. Great article, Jim. I think that every high school student should be taught these principles and steps (both by their parents and by the schools).

    I agree with cubiclegeoff that savings should be split into two categories – but I guess one should be enough for a start.

    Also, I agree with Mike that having a savings account in a different bank can make the discipline of saving much easier to learn.

  5. In my experience, most grads receive a nice chunk of change from friends/family in the form of graduation gifts. I would strongly suggest that if possible, they use these to jump start their emergency fund.

  6. Michael says:

    I wouldn’t suggest a “Savings” account. First off, your making 1% or less. Second, most have restrictions on the balance, number of transfers, etc.

    What I would suggest is having a primary checking account and secondary investment account where you can invest in something safe, like a municiple bonds ETF.

    Of course, I would also suggest keeping a nice “Buffer” of cash in your checking account at all times, but the savings accounts generally provide little to no benefit and can be tricky with certain fees. For example, most have “Only X number of withdraws per month”. If your using a debit card with overdraft protection, this can easily add up to 8 transactions, resulting in a fee that would wipe out your entire earnings for the next 2-3 years.

    In addition, I would suggest opening up a secondary checking account (as long as there are no fees involved). Having multiple no-cost checking accounts builds a relationship with that bank, provides multiple benefits (maybe one bank has free wire transfers while another has free checks for life, etc. Why settle for one bank that only offers a few benefits?) This also gives the customer high mobility.

    For example, X bank starts a monthly fee. If you only used X bank, you would have to go, open a new one at another bank, add it to all your payment accounts, etc etc.. If you had multiple accounts, you could say “Bye Bye X Bank” and transfer your funds to the other bank without much trouble.

    To avoid the inactivity fees, paypal ACH transfer in-out cash every so often (you can automate this I believe as a scheduled transaction). For example, using my account, I automatically deposit 1$ in every account, then 5 days later, withdraw it back.

    • cubiclegeoff says:

      As investment accounts can lose value (even bonds), I think that is the wrong approach. Sure a savings account doesn’t have great interest, but is meant to be a very liquid account that can be used in an emergency or to save up to a certain date. Added to that, the fact that it has a limited number of withdrawals is irrelevant because its for saving, not for using for normal spending. You shouldn’t use your debit card for your savings account, only for your checking. Also, an investment account would have added fees in order to buy and sell just to use the money, which would make it impractical for what you’re suggesting.

      Also, having multiple checking accounts is complex, and if you do your research, then you can stay with one account and be ok. If you have to open up another, then you do that, but there’s no need to have a couple just in case.

    • Saul says:

      The limit on savings account withdrawals is a federal regulation, I believe. However, I am curious what is the liquidity on muni bond ETFs.

  7. eric says:

    Completely agree with the advice. Having the proper accounts in place is one less hurdle to organize your finance. Of course most young people forget to look at the fees they’re being charged so it’s important to scope out the accounts you open.

  8. Eliot says:

    Great post. I would only add that with so many great choices of banks that do not charge ATM fees and reimburse any ATM fees charged by other banks, there’s really no reason to settle for a so-so bank just so you gain access to its ATMs. I have a checking account through Charles Schwab Bank that reimburses ATM fees and offers .5% interest. I believe USAA’s, Incredible Bank’s, and Fidelity’s checking accounts also reimburse ATM fees. Ally bank’s new checking account does the same. If you are willing to put up with the odd requirements, it may also make sense for recent grads to look at rewards checking accounts which often waive ATM fees and offer a super-competitive interest rate. I use ATMs fairly often (I don’t like carrying around cash so I usually take our 20 or 40 every time I need it) and it’s nice to not have to think about where the nearest BofA ATM is.

  9. jsbrendog says:

    this is great advice. the most shocking thing is that some people don’t know this or might think that it is stupid. shame

  10. What a great dialog going on here! I was searching for ideas for my newsletter and saw this. I have to add my two cents worth.

    1) I advise to research local credit unions. For instance, one of ours gives 4% on all checking accounts up to $1,000. It drops to 1% above that. You have to have a direct deposit to qualify, but there are no fees. (Don’t let fees eat up your interest.)

    Keep in mind that you need to out-pace inflation, which has been between 3.1 and 3.5% on average. If you aren’t making that, you are really losing money.

    2) Have 6 months savings built up for emergencies.

    3) As soon as you can afford it, buy a life insurance policy that isn’t associated with your job because when you leave your job, you leave your insurance.

    What if I don’t have a family and I’m still young? Believe me. Even if you don’t, you probably will have a family. The younger you are, the greater the return. If you buy Term, make sure you can upgrade it to a Permanent policy later on. (“Buy term and invest the rest” isn’t always good advice.) You can use your life insurance as a vehicle for saving and have tax advantages, flexibility, and freedom from having to go to banking institutions for loans. Pay yourself the interest instead.

    4) Make logical decisions. If you have 20K in an account getting 4% interest annually, don’t pay 10% on a loan to buy a 20,000 car. You are losing money.

    5) Lastly, but really not, pay yourself first. Put 10% of your income into your future. It’s amazing how compound interest takes over.

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