Market makers are trading firms that continuously provide prices at which they will buy or sell securities. Market makers are typically banks, brokerage firms or proprietary trading firms. Unlike traditional investors, they’re not in the business of betting whether the price of an asset will go up or down. They also don’t tend to hang on to securities for very long. Instead, market makers profit off the tiny price spreads that come from buying and selling securities rapidly.
Because they stand ready to do both sides of a trade, market makers are considered to be liquidity providers. Liquidity is the ease with which an asset can be bought or sold without affecting its price.
Key Points
• Market makers continuously provide prices for buying and selling assets, ensuring liquidity and market stability.
• Market makers earn profits through the bid-ask spread, a small margin between buying and selling prices.
• In liquid markets, bid-ask spreads are narrow; in volatile markets, spreads widen to manage risk.
• Market makers frequently use hedging strategies to protect against price fluctuations and reduce risk.
• Payment for order flow allows brokerage firms to offer zero-commission trading, benefiting retail investors with potential price improvements.
How Market Makers Work
In both stock and equity options trading, there are at least a dozen different exchanges. In order to provide prices across multiple exchanges, market makers rely on algorithms and ultra-fast computer systems to make sure their price quotes reflect the supply and demand for a security in the market.
Because of their use of such technology, market makers are sometimes called high-frequency traders. Here’s a closer look at the role market makers play in financial markets today.
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How Market Makers Earn Money
Market makers seek to profit off the difference in the bid-ask spread, or the difference between the price at which an asset can be bought and the price at which it can be sold.
Overview of Bid-Ask Spreads
Here’s a hypothetical example of how market making works.
Let’s say a firm provides a quote for $10-$10.05, 100×200. That means they’re willing to buy 100 shares for $10, while simultaneously offering to sell 200 shares at the price of $10.05. The first part of the offer is known as the bid, while the latter is known as the ask. The prices that market makers set are determined by supply and demand in the market.
This means an investor or broker executing on behalf of a client can buy shares from the market maker at $10.05. And another investor looking to sell shares, can do so at $10 to this market maker. The difference of 5 cents is how the market maker locks in a profit. While making pennies on each trade sounds miniscule, it can be massively profitable at huge volumes.
Bid-ask stock spreads tend to narrow when markets are more liquid and widen when markets are less liquid. This is because during periods of volatility, sellers are more inclined to sell while buyers are more likely to stay put, anticipating lower prices in the near future.
Because bid-ask spreads tend to widen during periods of stock volatility, it also means market makers are able to capture bigger profits when markets are turbulent. Additionally, because of the risk of holding onto securities while making markets on them, market makers often hedge their bets by getting exposure to other assets or shorting securities in separate trades.
Overview of Payment for Order Flow
Another way some market makers earn revenue is through a practice known as payment for order flow (PFOF). This is when retail brokerage firms send retail client orders to market makers who then execute the orders.
So let’s say for example, a mom-and-pop investor at home puts in a buy or sell trade via their brokerage account. The broker then bundles that order with other client orders and sends them to an electronic market making firm, which then fulfills the orders.
Market makers pay fees to brokerage firms for sending those orders, and this is how brokerage firms have been able to offer zero-commission trading to retail clients in recent years.
Payment for order is common and legal, but it’s come under controversy over the years with some critics saying the practice incentivizes brokers to boost revenue, rather than find the best prices for their customers. Market makers are required by regulatory rules to execute client orders with “best execution,” but execution quality can be defined by price, speed, or liquidity.
Defenders of PFOF argue that retail investors get “price improvement,” when customers get a better price than they would on a public stock exchange.
Designated market makers are trading firms on the New York Stock Exchange who are in charge of ensuring orderly trading of stocks listed on the New York Stock Exchange. Each company that chooses to list on the Big Board picks a DMM for its shares.
DMMs are supposed to add a human touch to stock exchange trading in today’s electronic markets. In contrast, the Nasdaq Stock Exchange, the second-biggest venue for U.S. equities, doesn’t have DMMs for its listed companies and trading is instead completely electronic.
Famous for wearing distinctive blue-colored jackets on the floor of the NYSE, DMMs used to be known as “specialists” back in the day. There used to be dozens of specialist firms in the 1980s, but these days there are just a handful of DMMs active on the NYSE floor.
The Takeaway
Market makers are intermediaries who provide prices all day in two-sided markets, where both bids to buy and offers to sell are quoted. Instead of making long-term bets on whether an asset will rise or fall, they make money from holding on to assets for short periods and profiting off their tiny bid-ask spreads. Market makers rely on high volumes in order to generate significant revenue.
Market makers are also sometimes called high-frequency traders because they use ultra-fast technology and algorithms to connect to multiple exchanges and quote numerous prices continuously. They’re considered important participants in modern financial markets because they speed up the pace at which transactions take place, particularly in stock and equity options trading.
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FAQ
What do market makers do in the stock market?
Market makers continuously provide prices for buying and selling assets, helping to ensure liquidity and market stability.
How do market makers generate profits?
Market makers earn profits through the bid-ask spread, a small margin between buying and selling prices.
What is a designated market maker?
Designated market makers are trading firms on the New York Stock Exchange who are in charge of ensuring orderly trading of stocks listed on the New York Stock Exchange. Each company that chooses to list on the Big Board picks a DMM for its shares.
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Disclaimer: The projections or other information regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results.
Options involve risks, including substantial risk of loss and the possibility an investor may lose the entire amount invested in a short period of time. Before an investor begins trading options they should familiarize themselves with the Characteristics and Risks of Standardized Options . Tax considerations with options transactions are unique, investors should consult with their tax advisor to understand the impact to their taxes.
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A clearinghouse is a financial institution that acts as a middleman between buyers and sellers in a market, ensuring that transactions take place even if one side defaults. If one side of a deal fails, a clearinghouse can step in to fill the gap, thus reducing the risk that a failure will ripple across financial markets. In order to do this, clearinghouses ask their members for “margin,” or collateral that is held to keep them safe from their own actions and the actions of other members.
While often described as the “plumbing” behind financial transactions, clearinghouses became high profile after the 2008 financial crisis, when the collapse of Lehman Brothers Holdings Inc. exposed the need for steady intermediaries in many markets. Regulations introduced by the Dodd-Frank Act demanded greater clearing requirements, turning the handful of clearinghouses in the country into some of the most systemically important entities in today’s financial system.
Key Points
• Clearinghouses act as intermediaries in financial markets, ensuring transactions complete even if a party defaults.
• Clearinghouses manage the clearing and settlement process, transferring assets and funds between parties.
• Margin requirements and default funds help provide layers of protection against financial instability.
• Clearinghouses gained prominence after the 2008 financial crisis, enhancing market stability.
• Regulators have raised concerns that clearinghouses may be too big to fail, concentrating financial risk.
How Clearinghouses Work
Clearinghouses handle the clearing and settlement for member trades. Clearing is the handling of trades after they’re agreed upon, while settlement is the actual transfer of ownership, or delivering an asset to its buyer and the funds to its seller.
Other responsibilities include recording trade data and collecting margin payments. The margin requirements are usually based on formulas that take into account factors like market volatility, the balance of buy-versus-sell orders, as well as value-at-risk, or the risk of losses from investments.
Because they handle investing risk from both parties in a trade, clearinghouses typically have a “waterfall” of potential actions in case a member defaults. Here are the layers of protection a clearinghouse has for such events:
1. Margin requirements by the member itself. If market volatility spikes or trades start to head south, clearinghouses can put in a margin call and demand more money from a member. In most cases, this response tends to cover any losses.
2. The next buffer would be the clearinghouse’s own operator capital.
3. If these aren’t enough to staunch the losses, the clearinghouse could dip into the mutual default fund made up from contributions by members. Such an action however could, in turn, cause the clearinghouse to ask members for more money, in order to replenish the collective fund.
4. Lastly, a resolution could be to try to find more capital from the clearinghouse itself again — such as from a parent company.
Are Clearinghouses “Too Big to Fail?”
Some industry observers have argued that regulations have made clearinghouses too systemically important, turning them into big concentrations of financial risk themselves.
These critics argue that because of their membership structure, the risk of default in a clearinghouse is spread across a group of market participants. And one weak member could be bad news for everyone, especially if a clearinghouse has to ask for additional money to refill the mutual default fund. Such a move could trigger a cascade of selling across markets as members try to meet the call.
Other critics have said the margin requirements and default funds at clearinghouses are too shallow, raising the risk that clearinghouses burn through their buffers and need to be bailed out by a government entity or go bankrupt, a series of events that could meanwhile throw financial markets into disarray.
Clearinghouses in Stock Trading
Stock investors may have learned the difference between a trade versus settlement date. Trades in the stock market aren’t immediate. Known as “T+2,” settlement happens two days after the trade happens, so the money and shares actually change hands two days later.
In the U.S., the Depository Trust & Clearing Corporation (DTCC) handles the majority of clearing and settling in equity trades. Owned by a financial consortium, the DTCC clears trillions in stock trades each day.
Clearinghouses in Derivatives Trading
Clearinghouses play a much more central and pivotal role in the derivatives market, since derivatives products are typically leveraged, so money is borrowed in order to make bigger bets. With leverage, the risk among counterparties in trading becomes magnified, increasing the need for an intermediary between buyers and sellers.
Prior to Dodd-Frank, the vast majority of derivatives were traded over the counter. The Act required that the world of derivatives needed to be made safer and required that most contracts be centrally cleared. With U.S. stock options trades, the Options Clearing Corp. is the biggest clearinghouse, while CME Clearing and ICE Clear U.S. are the two largest in other derivatives markets.
The Takeaway
Clearinghouses are financial intermediaries that handle the mechanics behind trades, helping to back and finalize transactions by members. But since the 2008 financial crisis, the ultimate goal of clearinghouses has been to be a stabilizing force in the marketplace. They sit in between buyers and sellers since it’s hard for one party to know exactly the risk profile and creditworthiness of the other.
For beginner investors, it can be helpful to understand this “plumbing” that allows trades to take place and helps ensure financial markets stay stable.
Invest in what matters most to you with SoFi Active Invest. In a self-directed account provided by SoFi Securities, you can trade stocks, exchange-traded funds (ETFs), mutual funds, alternative funds, options, and more — all while paying $0 commission on every trade. Other fees may apply. Whether you want to trade after-hours or manage your portfolio using real-time stock insights and analyst ratings, you can invest your way in SoFi's easy-to-use mobile app.
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FAQ
What does a clearinghouse do?
Clearinghouses handle the clearing and settlement for trades on the markets. Clearing is the handling of trades after they’re agreed upon, while settlement is the actual transfer of ownership, or delivering an asset to its buyer and the funds to its seller.
What role do clearinghouses play in the markets?
Since the financial crisis in 2008 and 2009, clearinghouses largely play a stabilizing role, while also clearing trades.
What protections help stabilize the markets as it relates to clearinghouses?
Margin requirements and default funds provide layers of protection against financial instability.
INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE
SoFi Invest is a trade name used by SoFi Wealth LLC and SoFi Securities LLC offering investment products and services. Robo investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser. Brokerage and self-directed investing products offered through SoFi Securities LLC, Member FINRA/SIPC.
For disclosures on SoFi Invest platforms visit SoFi.com/legal. For a full listing of the fees associated with Sofi Invest please view our fee schedule.
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
Options involve risks, including substantial risk of loss and the possibility an investor may lose the entire amount invested in a short period of time. Before an investor begins trading options they should familiarize themselves with the Characteristics and Risks of Standardized Options . Tax considerations with options transactions are unique, investors should consult with their tax advisor to understand the impact to their taxes.
¹Probability of Member receiving $1,000 is a probability of 0.026%; If you don’t make a selection in 45 days, you’ll no longer qualify for the promo. Customer must fund their account with a minimum of $50.00 to qualify. Probability percentage is subject to decrease. See full terms and conditions.
A checking account can be a convenient place to store your cash and manage daily transactions. Among its benefits: You can usually make as many transfers in and out of the account as you like. Also, your funds are likely to be insured.
There are, however, some cons, too. You probably won’t earn much or any interest for parking your money in a checking account, and you may be hit with an array of fees that nibble away at your funds.
Here, take a closer look at checking account pros and cons so you can pick the right financial product to suit your needs.
Key Points
• A checking account provides security and easy access to funds.
• Checking accounts can support direct deposits and convenient bill payments.
• A benefit of a checking account can be a small amount of interest, plus rewards and sign-up bonuses.
• Potential drawbacks include low interest and fees.
• Alternatives to checking accounts include prepaid cards and digital payment services.
What Is a Checking Account?
Simply put, a checking account is a safe place to stash funds and enable the flow of money in (what you earn and receive) and out (what you spend).
Whether held at a brick-and-mortar bank, an online bank, or a credit union, a checking account is often the hub of a person’s financial life. Your pay can be seamlessly direct-deposited, if you like.
For your everyday spending, you might schedule automatic payments for your mortgage and utilities, write a check when paying for a doctor’s appointment, and tap your debit card when treating yourself to a wine tasting with friends on the weekend.
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Benefits of Checking Accounts
Here’s a closer look at the pros and cons of a checking account, starting with the upsides.
Security
Yes, you could stuff your money under the proverbial mattress, but with a checking account, you have a secure spot for it, where it can’t get lost, stolen, or damaged.
If your bank is insured by the FDIC (Federal Deposit Insurance Corporation) or, in the case of a credit union, the NCUA (National Credit Union Administration), your account will typically be covered up to $250,000 per depositor, per insured institution, for each account ownership category.
Easy Access to Cash
Checking accounts allow you to access your money quickly and easily, whether you need to pay for a meal or something unexpected, like a school donation. Setting up direct deposit allows your paychecks to be transferred directly into your checking or savings account, with some banks offering access to cash up to two days early.
You can then tap your funds by using your checking account’s debit card, writing checks, snagging some cash from the ATM, or making a transfer.
Pay Bills Conveniently
Here’s another benefit of a checking account: Having a checking account means you can get your bills taken care of without much effort. You might set up recurring payments to a car loan, for instance, or use a digital payment app to send money to your roommate, a friend, or your yoga teacher. You can also typically move funds quickly via wire transfer, which can be especially useful for international transactions, and other methods as well.
Debit Card for Purchases
When you open a checking account, you’re usually provided with a debit card that’s linked to the account. Similar to a credit card, you can typically use your debit card to pay in person or online for anything from this week’s groceries to a cool new pair of shades to a matcha latte.
Unlike a credit card, however, debit cards pull funds directly from your checking account. They usually only let you dip into funds you actually have on deposit, which can help you keep spending in check and stay on budget, not to mention avoid credit card debt.
Rewards
Some checking accounts come with rewards that can be a nice perk. For example, when you open an account, you might get a sign-up bonus. Who doesn’t like free money? Or your debit card may carry rewards, similar to those of a credit card, such as cash back.
Direct Deposit Benefits
Direct deposit can be a seamless way to get paid; in fact, more than 95% of Americans get paid this way, according to National Payroll Week. Direct deposit sends cash, ready to spend, straight into your bank account, so you don’t have to deal with depositing a check or cash.
FDIC Insurance Protection
As noted above, most financial institutions (but not all) are insured by either the FDIC or NCUA. In the very rare event of a bank failure, you would be protected from loss up to those limits of $250,000 per depositor, per account ownership category, per insured institution. Note: Some institutions offer programs that provide even more than $250,000 in insurance.
Cons of Checking Accounts
As you might guess, there are advantages and disadvantages to checking accounts, as is the case with most financial products. Checking accounts are designed to serve customers’ everyday, short-term money needs and can have a few potential downsides to consider.
Low or No Interest Earned
While your money is sitting in your checking account, it is probably earning very low, if any, interest. For instance, as of June 2025, the average interest checking account rate was a meager 0.07% of one percent, according to the FDIC. Translated into dollars and cents, that means that if you kept $5,000 in your checking account for a year, you would only earn $3.50 in simple interest.
That said, there are high-yield and premium checking accounts available that pay heftier interest rates. These may come with minimum deposit and balance requirements. Online-only banks frequently offer these accounts without those barriers, however, and with interest rates that are several times higher than the national average.
Potential Overdraft and Other Fees
Sooner or later, many people will try to transfer more money out of their checking account than they actually have on deposit. It could be a simple math error, or they might have forgotten about that on-the-fly payment they made to contribute to, say, a friend’s baby shower gift.
Not having enough money in your checking account can lead to overdraft fees. The average charge currently stands at a steep $25 to $35, with an average (as of 2024) of $27.08. Also, even if you have overdraft protection — meaning you have linked accounts so that money can be pulled from savings into checking to cover payments, if needed — you may still be charged a fee. However, it’s likely to be lower than an overdraft charge.
Also, check the fine print when signing up for a new checking account: There can be other fees, such as account maintenance and out-of-network ATM fees (more on those below).
Security Risks
While banks are extremely safe overall, there is always a small possibility of a security risk (such as a hack). Losing or having your debit card stolen and used without your authorization is another concern— and it can be a common one. A card thief could potentially gain access to the funds in your checking account.
It’s vital to report the issue within two days of noticing the card is missing so that you’ll be liable for no more than $50 in unauthorized usage. Otherwise, you could be liable up to $500 or more depending on the circumstances.
Minimum Balance Requirements
Some checking accounts require the account holder to maintain a certain balance to avoid monthly account fees. Or they might want account holders to keep a certain sum on deposit in order to earn a premium interest rate. Depending on the institution, this minimum deposit could be several hundred or more than a thousand dollars. If your balance dips below this amount, you could be hit with fees and/or lose your interest rate.
Quite simply, checking accounts make sense for the vast majority of Americans. It typically serves as the hub of one’s daily financial life.
Some people, though, are unbanked, meaning they have not (or are not able) to access the usual banking services. If you are seeking a checking account and haven’t been able to secure one, you can try a few other options:
• It might be easier to get an account at a credit union, if you qualify for one based on where you live, your profession, or other factors.
• Your banking history may reveal some issues, such as multiple overdrafts, as tracked by ChexSystems (a kind of reporting agency for the banking industry). In this situation, you might qualify for a second-chance account. This kind of account may have higher fees and/or minimum balance requirements, but it can be a good way to show that you can handle an account responsibly. In some cases, a second-chance account can be a stepping stone to a standard checking account.
When Other Accounts May Be Better
There are some situations in which another kind of account could be better than a checking account. A few scenarios to consider:
• If you are hoping to park your money for a while and earn interest vs. spend it, a savings account can be a good bet. Some savings accounts have limits on how many transactions can occur per month (check the fine print). Whether or not that applies, you will likely earn a higher interest rate than you would with a checking account. For instance, the current average interest rate for a savings account is 0.38% vs. 0.07% for checking.
• For those who want their money to earn still more money, a high-yield savings account can offer still more earning potential. At the time of publication, some online-only banks were offering rates in the range of 4.5%.
• A CD (or certificate of deposit) can be another way to earn a higher return on money you keep in a bank. However, these don’t offer the accessibility of a checking account. You agree to keep your funds on deposit in return for the bank guaranteeing a certain interest rate and are usually penalized if you withdraw funds before the end of your time.
• For those who want spending power without a checking account, prepaid debit cards can deliver. You load funds onto them and can then spend or pay bills with them. They are typically backed by a major network, like Visa or Mastercard.
• One other option is to use digital payment services, such as Venmo and PayPal. These can allow you to move funds to shop and otherwise spend without a bank account.
Checking Account Features To Consider
If you are looking for a checking account, you may want to focus on these three considerations:
ATM Access and Fees
Since accessibility is a key selling point of checking accounts, you likely want your money to be within easy and affordable reach. Check out a financial institution’s network of ATMs and make sure they are near your usual haunts.
Also see what the charges are for using an out-of-network bank: Certain banks (especially online-only ones) may waive those usual out-of-network fees that can ding you; these currently average $4.77 a pop.
Online/Mobile Banking
Today, it’s par for the course for financial institutions to provide online banking features and mobile banking apps, but some provide more robust, user-friendly digital services and offer them for free.
As you consider your options, you might look for a bank that helps you save automatically. A round-up function that nudges purchases up to the next whole dollar amount and adds the extra money to your savings can be valuable.
Also helpful are dashboards that allow you to see your money (earnings, spending, and savings) and credit score at a glance, for no extra charge. This feature can help you budget better.
Overdraft Protection
As mentioned above, many people have those “oops” moments and overdraw their accounts. Some banks will give you free overdraft protection up to a certain sum. For instance, they might cover up to $50 of your overdraft without charging you the standard fees. This can be a valuable feature when you are deciding which financial partner is right for you.
Get access to higher APY, credit card cash back rewards, discounts, and more.
Account Maintenance Fees
As noted above, some banks will charge monthly account maintenance fees for holding a checking account at their institution. It can be one of the ways that banks make money. These fees can range from, say, $5 to $12 a month or more, which can take a bite out of your budget.
You may find that some banks, especially online ones, offer no-fee checking accounts. Or a financial institution may waive fees if you keep a certain amount on deposit across your accounts or if you meet other requirements.
Customer Service and Support
Another factor to consider is the kind and quality of customer service and support a financial institution offers. Some people may gravitate toward online banks which typically have 24/7 online support by phone or text chat. Others may prefer banking with a traditional bank where they can meet in-person with team members. Consider what’s important to you to make the best decision for your news.
The Takeaway
For many people, a checking account can be a reliable hub for their personal finance needs. You can store your earnings securely and still easily access your money to pay bills and fund daily purchases.
Interested in opening an online bank account? When you sign up for a SoFi Checking and Savings account with eligible direct deposit, you’ll get a competitive annual percentage yield (APY), pay zero account fees, and enjoy an array of rewards, such as access to the Allpoint Network of 55,000+ fee-free ATMs globally. Qualifying accounts can even access their paycheck up to two days early.
Better banking is here with SoFi, NerdWallet’s 2024 winner for Best Checking Account Overall.* Enjoy 3.30% APY on SoFi Checking and Savings with eligible direct deposit.
FAQ
Are checking accounts free?
Some are. You can often find free checking accounts from traditional and online-only banks as well as credit unions. While these accounts may be billed as “free,” keep in mind that some fees may apply, say, if you overdraft your account.
What happens if my checking is overdrawn?
If your checking account is overdrawn, that means you have tried to withdraw more money than you have in your account. This can lead to payments not being processed (a check bouncing, for example) and charges piling up. By linking a checking and savings account, you may be able to have funds automatically transferred from savings into checking to cover the shortfall. Your bank may charge you a fee, whether they cover the shortfall through overdraft protection or not.
Can I have multiple checking accounts?
There is usually no limit on how many checking accounts you can have. It can be convenient to have one for, say, your salary and your living expenses and another for a side hustle and related expenses.
Are checking accounts FDIC insured?
Most but not all checking accounts are FDIC-insured. You can look for this feature before opening an account. With FDIC insurance, you are covered for up to $250,000 per depositor, per account ownership category, per insured institution in the very rare event of a bank failure. Some banks have programs that offer even higher amounts of insurance.
Do checking accounts offer fraud protection?
Most banks will refund you if your account is hacked or your debit card is used without permission, provided you report it in a timely fashion. Check with your financial institution about their policies, but note that if you willingly sent money to an individual or business that turned out to be a scam, refunds are less likely.
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Annual percentage yield (APY) is variable and subject to change at any time. Rates are current as of 12/23/25. There is no minimum balance requirement. Fees may reduce earnings. Additional rates and information can be found at https://www.sofi.com/legal/banking-rate-sheet
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Although we do our best to recognize all Eligible Direct Deposits, a small number of employers, payroll providers, benefits providers, or government agencies do not designate payments as direct deposit. To ensure you're earning the APY for account holders with Eligible Direct Deposit, we encourage you to check your APY Details page the day after your Eligible Direct Deposit posts to your SoFi account. If your APY is not showing as the APY for account holders with Eligible Direct Deposit, contact us at 855-456-7634 with the details of your Eligible Direct Deposit. As long as SoFi Bank can validate those details, you will start earning the APY for account holders with Eligible Direct Deposit from the date you contact SoFi for the next 31 calendar days. You will also be eligible for the APY for account holders with Eligible Direct Deposit on future Eligible Direct Deposits, as long as SoFi Bank can validate them.
Deposits that are not from an employer, payroll, or benefits provider or government agency, including but not limited to check deposits, peer-to-peer transfers (e.g., transfers from PayPal, Venmo, Wise, etc.), merchant transactions (e.g., transactions from PayPal, Stripe, Square, etc.), and bank ACH funds transfers and wire transfers from external accounts, or are non-recurring in nature (e.g., IRS tax refunds), do not constitute Eligible Direct Deposit activity. There is no minimum Eligible Direct Deposit amount required to qualify for the stated interest rate. SoFi Bank shall, in its sole discretion, assess each account holder's Eligible Direct Deposit activity to determine the applicability of rates and may request additional documentation for verification of eligibility.
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The member’s experience below is not a typical member representation. While their story is extraordinary and inspirational, not all members should expect the same results.
Dr. Christine M. has always been goal-oriented about her finances. That approach worked well when she decided to become a doctor. She stretched an annual salary of $55,000 during her five years as a resident and fellow. Once she became a new doctor in private practice on the East Coast, she made paying down her medical school loans her top priority. By being frugal, she was able to pay them off in three years.
The road to becoming a doctor is long — 11 years at a minimum — and the average cost of medical school is expensive. The median medical school debt for borrowers in the Class of 2024 is $205,000, according to the Association of American Medical Colleges. And that’s not counting undergraduate student loans, credit card balances, or other debt.
But the hard work can pay off. The median annual salary for physicians and surgeons is $239,200. That’s a significant increase from the $65,100 median annual salary a first-year resident earns.
If you’re a doctor, the beginning of your career marks a new phase of your earning power. It’s also a prime opportunity to get yourself on sound financial footing, including paying off your medical school loans. That’s why budgeting is so important for doctors. These strategies can help you reach your financial goals.
Key Points
• New doctors should aim to save 30% of their income, with 25% for retirement and 5% for an emergency fund.
• Automating finances can help build good saving habits and ensure timely bill payments.
• New doctors can explore various investment vehicles for retirement savings, including HSAs and IRAs.
• Physicians may consider disability insurance to protect income in case of injury or illness.
• Develop a repayment strategy for medical student loans, such as income-driven repayment, using the avalanche or snowball method, or exploring medical loan refinancing.
Resist the Urge to Start Spending Right Away
After years of hard work and sacrifice, you may be tempted to treat yourself. But don’t go wild. “I think lifestyle creep is the biggest danger we see [among new doctors],” says Brian Walsh, CFP® and Head of Advice & Planning at SoFi. Leveling up early in your career can wreak havoc on your savings and financial health while setting unsustainable spending habits that are hard to break.
Automate your finances whenever possible. For instance, preschedule your bill payments and set up automatic contributions to your retirement account.
To encourage good spending habits, use cash or a debit card for purchases, Walsh suggests. You may also need to practice extra self-control. Because Christine was thrifty, she was able to triple her loan payments to $4,500 a month. She also made additional payments whenever she could. “You just have to keep reminding yourself what your priorities are because it’s easy to want more,” she says.
Get Serious About Savings
As a new doctor, you may not start your career until you’re in your thirties, which puts you behind the curve on saving for long-term goals. The good news: earning a higher income can help you make up for lost time.
Walsh advises early-career physicians to set aside 30% of their income for savings. Of that, 25% should be for retirement and 5% for other savings, like starting an emergency fund that can tide you over for three to six months. The remaining 70% of your income should go toward expenses, including monthly medical school loan payments.
The sooner you start saving and investing, the sooner you can enjoy compound growth, which is when your money grows faster over time. That’s because the interest you earn on what you save or invest increases your principal, which earns you even more interest.
Consider Different Investments
For investing your retirement savings, you may need to think beyond maxing out your 401(k) or 403(b), though you should do that as well. Walsh suggests new doctors tap into a combination of different investment vehicles. This strategy, known as diversification, may help protect you from risk. Here are some vehicles to consider:
• A health savings account (HSA), which provides a triple tax benefit. Contributions reduce taxable income, earnings are tax-free, and money used for medical expenses is also tax-free.
• An individual retirement account (IRA), like a traditional IRA or Roth IRA, can offer tax advantages. Contributions made to a traditional IRA are tax-deductible, and no taxes are due until you withdraw the money. Contributions to a Roth IRA are made with after-tax dollars; your money grows tax-free and you don’t pay taxes when you withdraw the funds. However, there are limits on how much you can contribute each year and on your income.
• After-tax brokerage accounts, which offer no tax benefits but give you the flexibility to withdraw money at any time without being taxed or penalized.
Two options to consider bypassing are variable annuities and whole life insurance. Walsh says they aren’t suitable ways to build wealth.
Regardless of the strategy you choose, keep in mind that there may be fees associated with investing in certain funds, which Walsh points out can add up over time.
Protect Your Income
There are a variety of insurance policies available to physicians, and disability insurance is one worth considering. It covers a percentage of your income should you become unable to work due to an injury or illness. If you didn’t purchase a policy during your residency or fellowship, you can buy one as part of a group plan or as an individual. Check to see if it’s a perk offered by your employer. Christine’s practice, for example, includes a disability plan as part of its benefits package. Monthly premium amounts vary, but in general, the younger and healthier you are, the cheaper the policy.
No matter how much you owe, having the right repayment strategy can help keep your monthly payments manageable and your financial health protected.
To start, consider the types of student loans you have. Federal loans have safety nets you can explore, like loan forgiveness and income-driven repayment (IDR) plans, which can lower monthly payments for eligible borrowers based on their income and household size.
Once you’ve assessed the programs and plans you’re eligible for, determine your goals for your loans. Do you need to keep monthly payments low, even if that means paying more in interest over time? Or are you able to make higher monthly payments now so that you pay less in the long run?
Two approaches to paying down debt are called the avalanche and the snowball. With the avalanche approach, you prioritize debt repayment based on interest rate, from highest to lowest. With the snowball method approach, you pay off the smallest balance first and then work your way up to the highest balance.
While both have their benefits, Walsh often sees greater success with the snowball approach. “Most people should start with paying off the smallest balance first because then they’ll see progress, and progress leads to persistence,” he says. But, as he points out, the right approach is the one you’ll stick with.
Explore Your Refinancing Options
Besides freeing up funds each month, paying down debt has long-term benefits, like boosting your credit score and lowering your debt-to-income ratio. And you may want to include refinancing in your student loan repayment strategy.
When you refinance, a private lender pays off your existing loans and issues you a new loan. This could give you a chance to lock in a lower interest rate than you’re currently paying and combine all of your loans into a single monthly bill. Some lenders like SoFi also provide medical professional refinancing.
Though the refinancing process is fairly straightforward, some common misconceptions persist, Walsh says. “People overestimate the amount of work it takes to refinance and underestimate the benefits,” he says. A quarter of a percentage point difference in an interest rate may seem inconsequential, for instance, but if you have a big loan balance, it could save you thousands of dollars.
That said, refinancing your student loans is not right for everyone. If you refinance federal student loans, for instance, you may lose access to benefits and protections, such as federal repayment and forgiveness plans. Weigh all the options and decide what makes sense for you and your financial goals.
The Takeaway
As a new doctor, you stand to earn a six-figure salary once you complete medical school and residency. But you’re likely also saddled with a six-figure student loan debt. Learning new strategies for saving and investing your money, and coming up with a smart plan to pay back your student loans, can help you dig out of debt and save for your future.
If you decide that student loan refinancing might be right for you, SoFi can help. Our medical professional refinancing offers competitive rates for doctors.
SoFi reserves our lowest interest rates for medical professionals like you.
Photo credit: iStock/Ivan Pantic
FAQ
How do I budget as a new doctor?
To budget as a new doctor, start saving right away and resist the urge to overspend. Set aside 30% of your income for savings — of that, 25% should go to retirement savings and 5% to other savings, like an emergency fund. Use the remaining 70% of your income to pay for expenses and bills.
In addition, automate your finances. Set up auto-pay for bills and automatic contributions to your retirement accounts, including 401(ks) and IRAs. Finally, develop a plan to repay your student loans. Explore different repayment plans to see which one is best for you.
How much debt does a new doctor have?
The median medical school debt for borrowers in the Class of 2024 is $205,000, according to the Association of American Medical Colleges. That’s not counting undergraduate student loans.
How much does a doctor make?
The median annual salary for physicians and surgeons is $239,200. That’s much more than the $65,100 median annual salary a first-year medical resident earns.
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The permanent portfolio investment strategy involves creating an investment portfolio that is equally diversified among four asset classes. It was introduced by investment advisor Harry Browne in his 1981 book, Inflation-Proofing Your Investments. The goal of the permanent portfolio is for it to perform well during both economic booms and recessions.
It aims to provide both growth and low volatility. Historically the strategy has been successful. But engaging in the strategy requires a bit of legwork, like learning how to build the portfolio, and considering the pros and cons of the strategy.
Key Points
• A permanent portfolio strategy includes investments in U.S. stocks, Treasury bills, long-term Treasury bonds, and gold to form the four equally diversified asset classes.
• The strategy hopes to generate returns across different economic environments.
• The strategy was designed with the goal of achieving steady growth while maintaining low volatility.
• Annual rebalancing is necessary with the permanent portfolio to keep each asset class at a 25% allocation.
• The conservative nature of the permanent portfolio may result in lower returns compared to more stock-heavy portfolios.
What Is the Permanent Portfolio?
The permanent portfolio is diversified equally with precious metals, Treasury bills, government bonds, and growth stocks. The allocation is as follows:
Although these investments can be volatile and incur losses, their values are not strongly correlated, so by holding some of each, investors may be able to prevent significant losses. The idea is that at least one asset in the portfolio is always working. Each asset class tends to (but does not necessarily) perform well in different conditions:
• Stocks tend to perform well during times of economic prosperity and are good for growth.
• Gold tends to protect from currency devaluations, perform well during inflation, and do fine during growth periods.
• Bonds are a safe investment that perform well during deflationary times and do fine during growth periods.
• Cash might protect from losses during recessions and deflationary times, and is liquid.
Gold and bonds are generally safe havens during a recession and inflationary times, while the stock market provides growth during economic booms. Cash is stable and creates a source of funding for rebalancing and downturns.
Another way of looking at it is by categorizing the four asset classes into four economic conditions:
• Prosperity: Stocks perform well during prosperous times, as public sentiment is positively correlated to stock market increases.
• Inflation:Gold investments perform well during inflationary times because the purchasing power of the dollar decreases, so people flock to gold as a safe haven.
• Deflation: When the price of goods and services decreases, deflation occurs. Long-term bonds perform well in this environment because interest rates decrease, which increases the value of older bonds.
• Recession: Cash is good to hold during a recession while other assets are at a low. Investors can buy up assets while they’re down and still have some money on hand if they need it.
Rather than trying to time the market and moving funds around accordingly, the permanent portfolio is a simple set-it-and-forget-it strategy for long-term investing.
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Historical Performance
The permanent portfolio has historically performed as it’s designed to. It grows steadily over time and doesn’t experience significant losses during market downturns. For example, during the 1987 market crash, utilizing the permanent portfolio would have only incurred losses of 4.5%, while a 60/40 portfolio would have dropped 13.4%.
In general, the permanent portfolio has a somewhat lower return than a 60/40 portfolio, but it carries less risk and volatility.
The permanent portfolio had an average annual return of 8.69% between 1978 and 2017, while the 60/40 portfolio earned 10.26%, and the 100% U.S. stock portfolio earned 11.50%. Within that time frame, the permanent portfolio outperformed the other two several times within five-year periods.
Note, of course, that historical performance is not indicative of future performance.
Pros of the Permanent Portfolio
There are several upsides to building a permanent portfolio:
• Simple, set-it-and-forget-it strategy. Once it’s set up, investors only need to rebalance their portfolio about once a year.
• Avoiding significant losses through diversification while gaining returns over time. The portfolio is designed to minimize volatility but still increase in value over the long term.
• Although assets such as stocks can grow significantly, they can also have significant downturns.
Cons of the Permanent Portfolio
Like any investment strategy, the permanent portfolio does come with some downsides:
• Stocks tend to grow more over time than the other assets included in the portfolio, so investors miss out on some of that growth by only having a 25% stock allocation.
• The permanent portfolio includes only U.S. stocks, so investors miss out on exposure to emerging markets and international stocks. When Browne developed the permanent portfolio, international stocks were not a popular investment, so he would not have included them in his allocation.
• Another potential con is that the permanent portfolio only includes Treasury bonds. Other types of bonds can also be good choices for diversification.
• Although cash is a fairly safe asset to hold during a depression, that type of downturn doesn’t happen often. By holding such a large amount of cash, investors miss out on growth opportunities.
• Overall, the permanent portfolio is fairly conservative, so investors could see higher returns using another strategy. Allocating more to stocks and alternative investments is likely to provide greater growth, but will carry greater risk.
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Building a Permanent Portfolio
Although the permanent portfolio strategy outlines the percentage of funds to allocate to different asset classes, investors still need to select specific assets to invest in. For example, investors might choose individual stocks for their portfolio, or they might invest in ETFs that include solely U.S. stocks or bonds. The upside of ETFs is they are easy to buy and sell, they minimize fees, and they provide diversification.
Managing a permanent portfolio is fairly simple once it’s set up. It’s a good idea to rebalance the portfolio at least once a year to ensure that the 25% allocations remain the same. If one area of the portfolio has grown or declined, investors can rebalance to even them out.
The Variable Portfolio
Some investors may decide that the permanent portfolio is too safe for them and they’d prefer a strategy conducive to higher growth. Using the variable portfolio method, investors put 5% to 10% of their money into riskier or more experimental investments. That way, the majority of holdings are still in the steady growth permanent portfolio, but investors can play around with some alternative investments as well.
Alternatives to the Permanent Portfolio
Although the permanent portfolio has its merits and has performed well historically, it isn’t the right choice for everyone. Some investors might want to allocate more of their portfolio to stocks, while others might want to diversify into more types of assets. There are many investing strategies out there to choose from, or investors can create their own.
Just because a particular strategy has performed well in the past doesn’t mean it will continue to do so in the future. It’s important for investors to do their own research and due diligence to decide what works best for their own goals and risk tolerance.
Below are some of the most popular strategies:
60/40
The 60/40 strategy is popular, especially among retirees, because it has performed well over the past century.
It involves creating a portfolio with 60% stocks and 40% bonds. Similar to the permanent portfolio, the 60/40 gives investors exposure to the growth of the stock market while reducing risk and volatility with the inclusion of bonds.
The benefit of the 60/40 strategy compared to the permanent portfolio is that it has a large stock allocation, but some still consider the 40% bond allocation too high. There has also been discussion in recent years about whether the 60/40 portfolio will continue to be a successful strategy in the coming decades.
There are downsides, too, which include the fact that a 60/40 portfolio will likely not provide the same returns as one more invested in stocks. Depending on your specific investing goals, that’s something to keep in mind. It’s also possible that stock and bond values could decline at the same time, leading to a fall in the overall value of the portfolio.
Business Cycle Investing
Those looking for an intermediate-term strategy might want to use the business cycle investing strategy for some or all of their portfolio. Using this strategy, investors keep track of the business cycle and adjust their investments according to which stage of the cycle the nation is in.
Different industries and types of assets do better within each stage of the cycle, so investors can make predictions about when to buy and sell each asset and invest accordingly. To execute this strategy effectively, it is a good idea to have an understanding of past market contractions and their catalysts. This strategy requires more time, research, and effort than long-term, set-it-and-forget-it strategies, but can be successful for those willing to put in the work.
It could be unsuccessful if investors aren’t able to stay on top of the news and happenings related to the business cycle, and are able to readjust their holdings and allocations accordingly. It requires a more active approach, in other words, which may not be suited for each individual investor.
Rule of 110
Investors subtract their age from 110 to figure out what percentage of their money to allocate to stocks and bonds. For example, a 40-year-old would create a portfolio of 70% stocks and 30% bonds. As the investor gets older, they rebalance their portfolio accordingly.
Dollar-Cost Averaging
Here, investors put the same amount of money toward any particular asset at different points in time. Rather than putting all of their money into the markets at once, they space it out over time. Utilizing the dollar-cost averaging strategy allows investors to average out the amount they pay for that asset over time. Sometimes they buy low and sometimes they buy high, but they aren’t attempting to time the market or predict what will happen.
Lump Sum Investing
With the most basic strategy of all, investors put all of their available cash into the stock market right away. There’s no waiting for a particular time or trying to figure out what else to invest in. The theory behind this is that the overall trend line of the stock market continues to go up over the long term, even if it has downturns along the way. This might be a choice for investors who simply want to take advantage of stock market growth and aren’t afraid of volatility.
Alternative Investments
In addition to stocks and bonds, investors may want to consider diversifying into alternative investments, which could include real estate, franchises, or farmland. While some alternative investments carry a lot of risk and require research, they can also come with significant growth. Conversely, alternative investments tend to be very risky and speculative, and could see significant losses as well. The risks associated with alternative investments are something all investors should consider.
The Takeaway
The permanent portfolio involves equally allocating your investments to four specific asset classes. Those classes include precious metals, Treasury bills, government bonds, and growth stocks. While this method has proven beneficial for some investors in the past, it has its potential downsides, and won’t be the right strategy for everyone.
Once you’ve decided what your investing strategy is going to be and created some personal financial goals, you’re ready to start building your portfolio.
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FAQ
How is the permanent portfolio allocated?
The permanent portfolio is diversified equally with precious metals, Treasury bills, government bonds, and growth stocks. Each asset class gets 25% within the permanent portfolio.
Who invented the permanent portfolio strategy?
The permanent portfolio strategy was introduced by investment advisor Harry Browne in his 1981 book, Inflation-Proofing Your Investments, with the goal of the permanent portfolio is for it to perform well during both economic booms and recessions.
What are some alternate strategies to the permanent portfolio?
Some potential alternatives to the Permanent Portfolio strategy that investors may check out include the 60/40 strategy, lump-sum investing, or the Rule of 110.
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Investment Risk: Diversification can help reduce some investment risk. It cannot guarantee profit, or fully protect in a down market.
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