Bank accounts are depository accounts. Bank accounts simply hold your money for you. Banks are good things. They provide a very safe place to put your money and they allow you to access your money in very convenient ways, like swiping your debit card or writing a check when you want to buy something. And, thanks to the rules and regulations banks operate under and insurance provided by the Federal Deposit Insurance Corporation, it is essentially guaranteed that the bank will have all the money you deposited whenever you ask for it back.
A brokerage account is very different. In contrast to a bank account, which can only hold money, a brokerage account holds both money and securities. Brokerage accounts are also sometimes referred to as investment accounts because their ability to hold securities allows the account holders to invest in capital markets.
That difference between bank accounts and brokerage accounts represents a tradeoff. Whereas bank accounts are very safe places to put your money, the return for keeping your money in a bank account is interest paid by the bank, and usually not very much. On the other hand, brokerage accounts allow you to invest in securities which involve higher levels of risk, but that risk presents the opportunity for greater rewards. An example helps illustrate the difference between the two.
If you deposit $100 in a bank account, you are entitled to have the bank return that $100 to you upon demand. In the meantime, your bank will essentially borrow that money from you and put it to work somewhere else, perhaps lending your $100 to another customer. The benefit to you is that the bank pays you interest on the amount you deposited. The rate of interest paid varies from bank to bank and customer to customer, but it’s typically a small amount. My bank is currently offering between 0.01% and 0.11% interest per year depending on how much you’ve deposited and what kind of customer you are. At those rates, your bank will pay you between one cent and eleven cents in interest for the year.
Of course, when your bank loans your money to someone else, your bank is likely to charge a much higher interest rate. According to Bankrate, average rates for personal loans start at 6% interest. That means that the bank could be making $6 in interest lending out your money while only paying you a few pennies. While that’s not unreasonable from the bank’s perspective, after all the bank bears the risk that the person to whom they loaned your money will default on the loan, and the bank must have $100 available to hand over to you anytime you ask for it, that still doesn’t seem like a very good deal from your perspective. In essence, your bank is putting your money to work for them.
Alternatively, if you deposit $100 in a brokerage account, you can put your money to work for you by investing it. As we explain here, the rewards for investing can really add up over time.
So, if you’re just looking for a place to keep your money for the short term, a bank account makes sense. But, if you’re saving for longer term goals, investing your money through a brokerage account may be the way to go.
At Evati, our goal is to help you achieve your financial goals. We understand that investing can be intimidating, but we strive to make the process as simple as possible because we strongly believe that ordinary people should have access to professional investment advice that has previously been accessible only by the wealthy. In just a few minutes, you can open a brokerage account with Evati and be on your way to investing in your future. Download the Evati app or click here to start down your path to financial wellness.