The 7 types of accounts you need to accelerate your wealth, according to a financial adviser
Courtesy Jeff Rose
- If you've got all or most of your money in a single investment account, you're missing serious opportunities to build wealth.
- One of the biggest wealth secrets is to earn money on your money, whether it's in checking, savings, or being put aside for retirement.
- It's a good idea to designate specific accounts for specific purposes, like paying your taxes (especially if you're self-employed) and investing in yourself.
- SmartAsset's free tool can help find a financial adviser to create your own wealth-building plan »
If you're serious about building wealth, there are seven types of accounts you need to have to make it happen. Don't worry if you don't have them right now - that's the whole point of this article. I didn't have them either when I began my wealth-building journey, but I added them as I moved forward. You can do the same.
And once you have them up and running, you're going to see your wealth begin to grow faster than you ever imagined. It's all about creating the right mix of accounts.
Let's jump right in with the seven types of accounts you need to accelerate your wealth.
1. High-yield checking accounts
I know what you're thinking: What does a checking account have to do with building wealth? After all, just about everyone has a checking account.
But the arrangement tends to be a bit different with the wealthy. The wealthy make sure their money is working for them, even in their checking accounts. That's why they favor interest-bearing checking accounts, paying rates at the top of the yield curve for that account type.
The basic idea is to make sure you're earning some kind of income, even on funds you expect to spend in the current month.
This is the exact opposite of how most people think. They may believe that since the money will be in the account only for a few days or weeks, there's no point worrying about earning income on it. But for the wealthy, it's about earning something on your money, no matter where you have it parked.
If you have a certain asset amount, you'll usually have access to a private banking or private wealth management account with a bank. That will often come with high-interest checking. But even if you don't have the large bankroll, there are still ways you can earn high interest on your checking.
There are online banks that specialize in paying high interest rates, even on checking accounts, like Ally Bank's Interest Checking Account and Charles Schwab's High-Yield Investor Checking Account (not that Schwab's must be linked to a Schwab One Brokerage account, which also requires no minimum investment and charges no monthly fees).
2. High-yield savings accounts
If you're not in the habit of scanning interest rates at least occasionally, you may have fallen into the trap of believing your local bank is paying you the highest interest available. Unfortunately, that isn't remotely true. Complacency with interest yields costs you money in the form of lost income. That's exactly what the wealthy don't do.
This process starts by understanding exactly what interest rate your bank is paying you on your savings. Next, you'll need to investigate the available alternative high-yield savings accounts. And trust me, the difference between the two is probably a lot bigger than you think.
Here's the problem … the typical bank is paying just 0.09% on savings. It's a solid bet you're not earning much more than that on your current savings arrangement. But there are plenty of alternatives.
Before we get into that, make sure you check the financial integrity of any institution that's paying high interest rates. First, make sure your deposits are fully FDIC-insured. Second, check the rating on the bank to make sure they're solvent. N0 matter how much interest an institution pays, it's not worth the risk if it may fail.
That said, there are plenty of high-quality options.
If you're not earning top interest rates on your savings, it's the equivalent of giving your bank a loan. Even if they're paying you 0.09%, the rate is practically nothing. And they'll be loaning out your funds for 4% on car loans and 20% or more on credit cards. You owe it yourself to earn as much on your savings as possible.
3. Tax savings accounts
This is one I didn't quite get it until I launched my own business. When you're self-employed, you have to make tax deposits throughout the year. Unlike an employee, you don't have withholding taxes taken out of each paycheck.
If you're self-employed, or if you expect to have significant non-employment income, you'll need to set up a tax savings account to be ready to file your income tax return. That will apply if you are operating a side business, freelancing, consulting, or working as an independent contractor.
You need to make quarterly tax payments, or at least have money set aside to pay your taxes at the end of the year. As a loose guideline, figure between 20% and 30% of the income you earn from non-wage sources should be paid estimates or set aside.
If you want to be really accurate, have an accountant or tax preparer analyze your income for the year and let you know how much you should be allocating for tax payments.
If your year-end tax liability from your extra income will be more than a few hundred dollars, you can be hit with a large tax bill when you file your return. Even worse, the IRS imposes penalties and interest on nonpayment or underpayment of income tax due.
If you're making estimated quarterly tax payments, you'll need to accumulate funds in your tax savings account as you earn them. This will be even more important if you plan to hold the funds to pay your additional tax liability when you file your return. Note that a "tax savings account" is not a different banking product - it's just a designated use for a savings account, like an emergency fund would be.
You should plan to accumulate the funds in a high-yield savings account. Even though the purpose of the money will ultimately be to pay your tax bill, you should still give yourself the benefit of earning high interest on those funds. It's a way to build additional wealth even on money earmarked for other purposes.
4. Personal equity fund
Hopefully, my use of the word "personal" in the name of this account doesn't cause you to confuse it with an emergency fund. That's not what it is at all. Everyone should have an emergency fund, and it should be held in a high-yield savings account so you can access the funds quickly when an unexpected need arises.
But a personal equity fund is something completely different. And unlike the other account types on this list, it's not for investing in financial instruments either. Instead, it's a fund you create to invest in yourself.
Investing in yourself may be the most overlooked type of investment there is, but it's also one of the very best. This is where you allocate funds to cover the cost of programs you'll participate in to improve your career and business skills. It can include coaching programs, mastermind groups, conferences or obtaining needed certifications. And that's just the short list.
Every wealthy person I know recognizes the value of investing in themselves, even if they don't have a designated personal equity fund for that purpose. But they do allocate money toward their personal development, self-growth, making themselves more marketable - you name it.
It's an investment of time and effort, as well as money. The personal equity fund will cover the money part, and that's more important than you might realize. By having an account set up specifically for these expenses, you'll be establishing the intent of self-improvement, as well as providing yourself the funds to do it. (Like the tax savings account, this isn't a different product your bank offers - it's a specific use for an account like a high-yield savings account.)
The more money you can earn, the more you'll have available for every other investment on this list. No matter who you are, that starts with making an investment in yourself to make that happen.
5. Roth IRA
Even if you're covered by an employer-sponsored retirement plan work, a Roth IRA has an advantage not available to any other retirement plan. It's tax-free income in retirement. If you're seriously interested in building long-term wealth, this is a component you need to add to your portfolio.
A Roth IRA is a particularly good strategy early in your wealth-building process. The plan does come with income limits. If you exceed those limits, you won't be able to make direct contributions to the plan. This is unlike contributions to a traditional IRA, where even if you are covered by an employer plan and exceed certain income limits, you can still make contributions but they won't be tax-deductible. With the Roth IRA, once you've reached those limits, you won't be able to make contributions, period.
But even if you exceed the limits for a Roth IRA contribution, there's another way you can make it work. It's the Roth IRA conversion. You'll make a non-deductible contribution to a traditional IRA, then do a conversion of those funds to a Roth IRA. This is often referred to as a backdoor Roth IRA contribution, and it can be done tax-free if it's made with non-deductible traditional IRA funds.
Even though a Roth IRA contribution isn't tax-deductible, the investment income you earn on the account is tax-deferred. But once you reach age 59 ½, and as long as you've been participating in the plan for at least five years, any withdrawals you make from the account will be tax-free. That includes both your contributions and the investment earnings they've accumulated.
You can open a Roth IRA just about anywhere. That includes a bank, credit union, brokerage firm, or a robo-adviser, like Betterment or Wealthfront.
An unexpected benefit of a Roth IRA, and one of the reasons I'm such a strong proponent, is that it's an excellent account to learn how to invest. For example, you'll need to meet with the trustee that will hold your account. That's how you'll learn about your investment options and the specifics of how the account works.
And if you choose self-directed investing through a brokerage firm, you'll get hands-on experience investing. Once you become familiar with that process, it'll help you increase your wealth throughout your life.
6. Self-directed 401(k)
Do you notice the term self-directed? That's not an accident - it's a special type of 401(k) plan that allows you to build wealth much more quickly.
Being self-employed, I was able to set up a self-directed 401(k) plan for myself and my wife that enables us to make tax-deductible contributions of $110,000 per year. This is clearly not a typical 401(k) plan, like the one your employer offers.
The large contribution amount will give you a great big tax deduction. And it also provides an opportunity to earn tax-deferred income on a very large plan balance.
But the self-directed aspect of the account is one of the biggest advantages. You can open a self-directed 401(k) plan with a large investment broker, and have virtually unlimited investment options. Stocks, bonds, mutual funds, exchange traded funds, real estate investment trusts, options, commodities - you name it - you can hold it in a self-directed 401(k) plan.
It goes even farther than that. Self-directed 401(k)s are how wealthy people are able to invest their retirement money in unconventional investments, like private equity deals, real estate, and even small business ventures.
If you have a significant amount of self-employed income, this is an account you need to have. It may be the single best wealth-building investment plan available.
7. Regular investing account
This can be an individual or joint investment account. We're not concerned about tax-sheltered investing here - that's covered by some of the accounts above. This is more of a catch-all account where you can invest above and beyond the other account types.
You can use this account to invest anyway you like. For example, you can use it to invest in individual stocks, bonds, options, real estate investment trusts. It's completely up to you.
Once again, there are advantages to this type of investing. But the purpose may be for a medium-term goal, providing you with capital for a future purpose, without needing to liquidate your retirement savings early.
There's also something unique about this type of account. I've seen multimillionaires who still maintain the account, mainly to use it as play money!
What do I mean by play money?
Maybe you want to get into day trading, options, dabbling in cryptocurrencies, or even shorting stocks or options. A regular investment account is where you'll do this. It's play money because your long-term financial survival doesn't rest on this account. You're free to do whatever you want with it.
The rest of your accounts are set up to provide predictable, long-term growth. But this is the account where you can "scratch an itch." That might be participating in a type of investing you find interesting, challenging, or stimulating. It might just be something you've heard about and want to try. This is the account to do it in.
This type of investing is more risky and hands-on than everything else we've discussed up to this point. And for that reason, it should be only a small percentage of your total investment portfolio. You're playing here, so if it doesn't work out your overall financial security won't be affected. That's another reason why I'm referring to it as play money.
The truth is, investing can (and should) be kind of boring. But this is the type of account where you can spice things up a bit and have some fun. And in the process, you may even learn a few things about investing you didn't before.
All these accounts are working toward your financial goal
This is the whole purpose for having seven types of accounts. Though each is different from the others, it serves an important purpose in the grand scheme of things, which is to help you achieve your financial goals.
For example, maybe you hope to retire at 45. Each of these individual account types should be set up in a way that will move you in that direction.
Even if you don't have all these accounts set up right now, don't sweat it. Investing is a work-in-progress, and you can add one account at a time. Get comfortable with one type, then move on to another. As you add new accounts, try to make it fun. Yes, investing can be boring, but watching your wealth grow is anything but.
Jeff Rose is an entrepreneur disguised as a certified financial planner, author and blogger. Jeff is an Iraqi combat veteran having served in the Army National Guard for nine years, including a 17-month deployment to Iraq in 2005. He's best known for his award-winning blog GoodFinancialCents.com and book, "Soldier of Finance: Take Charge of Your Money and Invest in Your Future." He's also the founder of Wealth Hacker Labs, a movement to teach accelerated wealth-building strategies to future generations.
Disclosure: This post is brought to you by the Personal Finance Insider team. We occasionally highlight financial products and services that can help you make smarter decisions with your money. We do not give investment advice or encourage you to adopt a certain investment strategy. What you decide to do with your money is up to you. If you take action based on one of our recommendations, we get a small share of the revenue from our commerce partners. This does not influence whether we feature a financial product or service. We operate independently from our advertising sales team.