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When planning a move to a new city or state, the cost of living is an important consideration. Here’s why: Cost of living tells you how much money it takes to maintain a basic standard of living in a given place. If you were offered your dream job in a city 1,000 miles away, you’d want to know whether the salary would allow you to live well…or whether you’d have to be on a super tight budget.

Location typically plays a major role in determining the level of income needed to finance your lifestyle. For instance, a dollar doesn’t buy as much in New York as it would in Des Moines. If the cost of living is higher because you live in a major city, you’ll likely have to allocate more of your budget toward everyday expenses, such as housing, food, and transportation.

It’s important to understand the factors that affect cost of living calculations and what a higher or lower cost of living means for your finances. Otherwise, you could wind up with an uncomfortable level of “sticker shock” if you relocate.

What Is the Cost of Living?

The cost of living is the cost to cover basic household expenses. The cost of living can vary from state to state and city to city. As you might guess, renting a 1,500-square-foot home is likely to be much more affordable in a small town in the middle of the country than doing so in a hip neighborhood in San Francisco.

That said, you can also have different costs of living within the same metro area. For example, someone who owns a home in the suburbs of a major city may have higher or lower expenses compared to someone who lives downtown.

In terms of what the cost of living is used for, it’s a gauge for determining affordability. Before moving to a new location, you might look at the cost of living in that area to help you decide if it’s realistic for your budget.

How Does the Cost of Living Work?

Cost of living calculations work by measuring how much it costs to live in a specific location, using basic living expenses as a guide. The cost of living is not static; it can go up or down over time. Looking at cost of living trends for a certain city, region, or state can give you an idea which way consumer prices are trending.

There are a number of entities that perform cost of living calculations. The Council for Community and Economic Research, for example, maintains a cost of living index for participating cities across the U.S. Other organizations calculate cost of living for locations around the world.

On a personal level, the most important question to ask is, “What does the cost of living mean for me?” The simple answer is that cost of living can determine how far your income is able to go toward funding your lifestyle.

Factors That Determine Cost of Living

When discussing cost of living and expenses, you’re talking about necessities. In other words, the things you need to spend money on to live each month. According to the Economic Policy Institute, that includes:

•   Housing

•   Food

•   Childcare

•   Transportation

•   Healthcare

•   Taxes

•   Other necessities, such as clothing, household supplies, and personal care items

Cost of living calculators use prices for those types of expenditures in a particular area to determine how much it costs to live there on average. Consumer prices for goods and services are largely a product of supply and demand, and what’s happening with inflation. Inflation is a general upward trend in prices over time.

When inflation is higher, prices tend to rise across the board, which brings a higher cost of living. Even when inflation is lower, prices may still be higher in some areas than others if there’s higher demand for goods and services.

Calculating Cost of Living

Cost of living indexes collect information about various costs for different cities and locations, then use average prices to determine how much it costs to live there. If you’re comparing two cities, you can use a cost of living index to see which one is less expensive.

If you’d like to calculate your personal cost of living, you’d use your spending history to determine your average monthly expenses for these categories:

•   Housing

•   Food

•   Transportation

•   Utilities

•   Childcare, if applicable

•   Healthcare

•   Taxes

•   Other necessary expenses

Using those numbers can tell you how much it costs to maintain your basic standard of living each month. You can also add in your average monthly spending for debt repayment or non-essentials or discretionary expenses, like dining out, travel, or recreation, to get a sense of what your actual cost of living adds up to.

What Is the Cost of Living Index?

Generally speaking, a cost of living index is a measurement of average prices. Similar to a stock market index, a cost living index is meant to provide a benchmark for comparison. The Consumer Price Index (CPI) is often referred to as a cost of living index, though that description isn’t entirely accurate.

The CPI measures the average change in prices over time for a market basket of consumer goods and services. That’s how the U.S. Bureau of Labor Statistics (BLS) defines the Consumer Price Index. The CPI isn’t a true cost of living index but an inflation index. Changes to the CPI can be an indicator of how inflation is changing; whether it is rising, falling, or remaining flat.

Does Cost of Living Vary State by State?

The cost of living by state is not uniform and what you might pay to live in one state could be very different from what you’d pay to live in another. That’s important to keep in mind if you’re considering moving across state lines to a new location. The more expensive a state is, the less purchasing power your money holds.

For example, the California cost of living index is much higher than the Texas cost of living index. So why do some states have a higher cost of living? Again, it depends largely on things like supply and demand, though taxes and average incomes can also play a part.

When the average income in a state is higher and job opportunities abound, that can lead to an increase in people moving to the state. That means more demand for housing, which can send home and rental prices soaring. More people can also mean more demand for everyday goods and services, such as food or utilities. As demand rises, prices can follow suit.

So, in our example above, if you were living in Texas in a two-bedroom rental apartment and were offered a job at the same salary in California, you’d face a higher cost of living. If you moved there, you might have to rent a smaller home. Your groceries would likely be more expensive as well as your other monthly necessities. You might find you couldn’t eat out or go to concerts as often since prices are higher.

Recommended: What Percentage of Income Should Go to Rent and Utilities?

Which State Has the Lowest Cost of Living?

As of 2024, West Virginia had the lowest cost of living in the U.S., with a cost of living index of 84.3. For perspective, cost of living indexes are generally based on 100 as an average. So an index of 84.3 means that the cost of living in West Virginia is 15.7% less than the national average.

Housing, which is typically the biggest expense most people have, is nearly 40% cheaper in West Virginia compared to the U.S. average. The median sale price for a home there was $284,000 as of January 2024.

Which State Has the Highest Cost of Living?

Hawaii is the most expensive place to live in the U.S., with a cost of living index of 188.4. Housing is more expensive there than in any other state in the country, with a median list price of $714,100 as of January 2024. A home buyer would have to shell out considerably more to live in Hawaii’s natural paradise than elsewhere in America.

But housing demand isn’t the only factor. Higher taxes and higher costs for transporting goods and materials to the state are some of the other factors that drive up the cost of living in Hawaii. Other states that rank among the most expensive include New York, California, and Massachusetts.

How Much Should Your Cost of Living Be?

Your cost of living should be a figure that, given your income, you can reasonably afford to pay. When your expenses exceed your income, that can cause shortfalls in your budget each month. You may need to use credit cards or loans to fill the gap, which can leave you with a pile of bills, wondering how to pay off high-interest debt.

When calculating your ideal cost of living, start with your income. Then work your way backwards to determine how much you should be spending on things like housing, food, transportation, utilities, and other necessities. If your income comfortably covers those things, you can then decide how much to allocate to savings, debt repayment, or “wants” like travel and entertainment.

Also, consider your household size. The cost of living for a single person can be very different from the cost of living for a family of four. So you may need to allocate more of your budget for necessities if you have a spouse, partner, or children in your household.

Quick Tip: If you’re saving for a short-term goal — whether it’s a vacation, a wedding, or the down payment on a house — consider opening a high-yield savings account. The higher APY that you’ll earn will help your money grow faster, but the funds stay liquid, so they are easy to access when you reach your goal.

Tips to Improve Cost of Living

If you’ve run the numbers and your cost of living is higher than you’d like it to be, you aren’t necessarily out of luck. There are some things you can do to try and bring it down. Here are some ideas for ways to reduce your cost of living:

•   Eliminate unnecessary spending from your budget.

•   Move your money to a different financial institution to avoid bank fees and/or earn higher interest.

•   Plan meals at home, and cut down on restaurant meals.

•   Consider refinancing student loans or your mortgage to lower your interest rate.

•   Consolidate credit card debt using a 0% balance transfer offer.

•   Shop around for better rates on auto, homeowners, or renters insurance.

•   Aggressively pay off debt.

•   Consider moving to a cheaper area.

•   Take on a roommate to share expenses.

•   Downsize into a smaller home.

•   Sell a vehicle if you own more than one.

Some of these money-saving ideas are relatively easy to implement; others may seem a bit more extreme. But the more you can cut your expenses, the easier it may be to improve your cost of living.

You can also research different ways to make more money. That might mean taking a different job, getting a part-time gig, or starting a side hustle. If you’re contemplating a move for a higher-paying role, remember to factor in the cost of living in a new location to see how far a higher salary might go. A higher cost of living could eat up the salary boost you’ll receive, and so you’d want to be prepared for that.

Managing Finances With SoFi

Achieving a manageable cost of living starts with keeping a close eye on your budget and spending. Even making small changes, such as cutting out high banking fees and earning more interest, can free up more cash that you can use to save and fund your financial goals.

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.

https://www.sofi.com/signup/banking/v1“>

FAQ

What is a cost of living adjustment?

The Social Security Administration (SSA) applies a cost of living adjustment to Social Security benefits, based on changes to the Consumer Price Index. That means benefits can rise as the cost of living does. In other words, these adjustments are designed to ensure that recipients’ benefit payments are able to keep pace with inflation.

How can I compare the cost of living between two cities?

The easiest way to compare the cost of living between two cities is to use a cost of living index, which measures the relative cost of living in different areas of the U.S. You can subtract the cost of living index for the city that’s lower from the one that’s higher to figure out how much cheaper it is.

Which country has the highest cost of living?

Monaco is the most expensive country to live in. The average monthly cost of living there, as of 2024, is $6,538.

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SoFi Checking and Savings is offered through SoFi Bank, N.A. Member FDIC. The SoFi® Bank Debit Mastercard® is issued by SoFi Bank, N.A., pursuant to license by Mastercard International Incorporated and can be used everywhere Mastercard is accepted. Mastercard is a registered trademark, and the circles design is a trademark of Mastercard International Incorporated.

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

Eligible Direct Deposit means a recurring deposit of regular income to an account holder’s SoFi Checking or Savings account, including payroll, pension, or government benefit payments (e.g., Social Security), made by the account holder’s employer, payroll or benefits provider or government agency (“Eligible Direct Deposit”) via the Automated Clearing House (“ACH”) Network every 31 calendar days.

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.

See additional details at https://www.sofi.com/legal/banking-rate-sheet.
*Awards or rankings from NerdWallet are not indicative of future success or results. This award and its ratings are independently determined and awarded by their respective publications.

We do not charge any account, service or maintenance fees for SoFi Checking and Savings. We do charge a transaction fee to process each outgoing wire transfer. SoFi does not charge a fee for incoming wire transfers, however the sending bank may charge a fee. Our fee policy is subject to change at any time. See the SoFi Bank Fee Sheet for details at sofi.com/legal/banking-fees/.
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.

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A checking account is one of the most useful items you can have in your financial toolbox. You can use a checking account to pay bills, get paid early with direct deposit, or build your savings through automatic transfers.

However, it’s possible you’re not getting the most out of your account. Recognizing some of the most common mistakes you’re making with your checking account could help you to save money and time.

Ready to optimize this aspect of your financial life? Read on to learn:

•   Common mistakes you’re making with your checking account

•   Tips for improving your banking habits

Why Banking Mistakes Can Be Costly

Making mistakes with your bank account could cost you in more ways than one. It’s possible that you’re overpaying bank fees unnecessarily, missing out on valuable interest earnings, and possibly leaving yourself vulnerable to fraud. You may also be short-changing yourself and missing out on benefits and features if you’re using the wrong type of bank account for your needs.

Here’s why these issues can cost you:

•   High fees are generally not a good thing, as they can nibble away at your balances over time.

•   Losing out on the best interest rates means your money has less room to grow.

•   Fraud can potentially be the biggest drain on your accounts, if your debit card or bank account is used to make unauthorized withdrawals or purchases.

The good news is that it’s relatively easy to get back on track. That starts with knowing which checking account mistakes to avoid. You’ll learn about them next.

11 Checking Account Mistakes to Avoid

Managing a checking account shouldn’t be complicated. Here are 11 of the biggest checking account mistakes that you’ll likely want to sidestep.

1. Not Shopping Around

Sticking with the same bank for years may be comfortable, but it doesn’t necessarily mean you’re getting the best deal. It’s a mistake not to shop around for better banking options, as banks regularly introduce new benefits and features to attract customers.

It’s also incorrect to assume that switching banks is time-consuming or difficult. Many banks offer switch kits that help to simplify the process of transitioning your accounts over. These kits include a checklist of steps to complete to get your new accounts open and shut down your old ones if you choose to do so.

2. Overlooking the Benefits of Online Banks

How you use your checking account matters but it’s also important to consider where you keep it. Online banks can offer benefits you don’t always get at traditional banks or credit unions, such as lower fees or higher interest rates for deposit accounts. These two features could help you build wealth.

Opening an online checking and savings account is usually something you can do in just a few minutes. The trade-off of choosing an online bank is that you don’t have branch banking access. Comparing online banking pros and cons can help you to decide if it’s right for you.

3. Paying a Monthly Maintenance Fee

Banks can charge monthly maintenance fees for having a checking account. In some cases, you might pay these fees for savings and money market accounts as well. Paying these fees is a mistake if there are ways to get around them.

Your options for avoiding monthly maintenance fees might include:

•   Meeting a daily or monthly minimum balance requirement

•   Scheduling a qualifying recurring direct deposit

•   Maintaining a minimum balance across multiple linked accounts at the same bank

•   Making a certain number of purchases with your debit card each month

You could also avoid monthly maintenance fees by moving to an online bank. Online banks tend to be more fee-friendly than traditional banks, and you could earn a higher rate on interest-bearing accounts as well.

4. Triggering ATM Fees

Here’s another common mistake you may be making with your checking account: When you need quick cash, you hit the first ATM you come across. Convenient, yes, but that’s a problem if your bank charges ATM fees.

What are ATM fees? They’re fees you pay to use another bank’s machine. Typically, your bank won’t charge if you use their ATMs. But they might tack on a foreign ATM surcharge if you use a machine that’s out of the bank’s network. The ATM owner can also charge a fee of their own. Typically, out-of-network ATM fees will cost you between $2.50 and $5 per transaction and possibly even more.

Knowing where you can withdraw cash fee-free is a simple way to avoid that mistake. You might also consider looking for a bank that reimburses foreign ATM fees each month. Some banks offer reimbursement, either as a flat dollar amount or up to a certain number of foreign ATM fees per month.

5. Not Keeping Enough in Your Account

Maintaining a lower balance in your checking account isn’t necessarily a bad thing, but it could put you at risk of incurring overdraft of non-sufficient funds (NSF) fees.

Banks can charge overdraft fees to complete transactions when you don’t have enough money in your account. Non-sufficient funds fees may apply when you don’t have enough money in your account and the bank cancels or rejects the transaction.

In terms of how much you’ll pay for NSF vs. overdraft fees, that depends on the bank. However, it’s not uncommon for banks to charge anywhere up to $40 for these fees.

You could avoid overdraft fees by enrolling in overdraft protection. What is overdraft protection? It’s a service that allows banks to transfer money automatically from your savings account to checking if you’re in danger of overdrafting your account. You can avoid high overdraft fees by opting in, though banks may charge a smaller transfer fee.

6. Keeping Too Much Money in Checking

Keeping too much money in checking could also be a mistake if you’re missing out on interest earnings. Siphoning off some of the money in checking into a high-yield savings account or money market account, for example, could allow you to earn a competitive interest rate and APY on your balances.

It’s also important to consider how FDIC coverage limits apply to checking accounts. The Federal Deposit Insurance Corporation insures deposits up to $250,000 per depositor, per account ownership type, per financial institution. If you keep more than that in checking, you could be at risk of losing money in the rare event that your bank fails.

7. Choosing a No Frills Checking Account

A basic checking account should have all the features you need to pay bills, deposit money, or make purchases with a linked debit card. But a specialty account could offer a wider range of benefits.

For example, a high-yield checking account earns interest on balances. That’s like getting free money just for keeping a balance in checking. You will, however, have to pay tax on the interest you earn at the end of the year.

8. Missing Out on Potential Rewards

Another checking account mistake to avoid is losing out on potential rewards and bonuses. What are reward checking accounts? These are bank accounts that reward you with points or cash back for completing certain activities. For example, you might earn rewards when you make a specific number of debit card purchases each month or link a savings account.

These accounts are similar to rewards credit cards but the difference is you’re spending your own money to earn them, rather than borrowing from the credit card company. They can offer you some nice perks as you conduct your usual banking business.

9. Not Protecting Your Account When You Shop Online

Shopping online is convenient and you might be able to save money versus shopping in store if you’re using promo codes or coupons at checkout. However, you could be putting your checking account at risk if you’re shopping over unsecured WiFi networks or making purchases on untrusted websites.

A simple way to verify a site’s authenticity is to look for “https” in the site’s address. That indicates the site uses a Secure Sockets Layer certificate to encrypt and protect user data.

You can also protect yourself by not storing your debit card information at the checkout. If you’d like to be able to automatically enter your debit card details to pay, you can add them to a secure mobile wallet like Google Pay, Apple Pay, or Samsung Pay.

10. Not Enrolling in Email and Text Alerts

There are different ways to keep track of your bank accounts, including online and mobile banking. If you don’t always have time to log in, you could use email and text alerts to monitor your accounts instead.

Banks can allow you to set up different types of alerts, including notifications for:

•   Low balances

•   New credit transactions

•   New debit transactions

•   Updates to your personal information or login information

•   New linked accounts

•   New wire transfer transactions

•   Failed login attempts

Not using alerts can be a mistake as it can save you time as you manage your financial life.

Enrolling in alerts can also help you to spot potentially fraudulent activity before someone is able to do any major damage with your account.

Recommended: The Biggest Money Scams in the U.S.

11. Using Weak Passwords

Your password is your entry key to your online and mobile banking accounts and it’s important to choose a strong one. The stronger your password, the more difficult it might be for hackers to steal your information, and your money.

If you’re using weak passwords that are easy to guess, you could be leaving yourself open to fraud. It’s also a mistake to reuse the same passwords to log in to multiple accounts. If a hacker gets their hands on the password, they could have instant access to bank accounts, credit cards, investment accounts, email accounts, and any other accounts you manage online.

Choosing strong passwords and updating them regularly can help you avoid that scenario. If you have trouble remembering passwords, you might consider storing them online in a secure password keeper.

Ways to Improve Your Banking Habits

Building better habits can take time, but it may be well worth the effort if you’re able to avoid making common checking account mistakes. Here are a few ways to improve your banking habits:

•   Check your accounts regularly. Logging in to your bank accounts once a day or every few days is a simple way to check your transaction history and balances so you know what you have to spend.

•   Sign up for alerts. Banking alerts can help you to spot potential fraud, track your balances, and know what’s being debited or credited to your account. It’s typically free to enroll, and you can personalize which alerts you want to receive.

•   Maintain a buffer. Getting in the habit of maintaining a cash cushion in your checking account can help you to minimize your risk of overdraft. For example, you might want to keep an extra $500 to $1,000 in your account at all times and not let your balance fall below that amount.

•   Review your accounts. Reviewing your checking account once a year can be a good way to see what you’ve paid in fees and what benefits you’ve enjoyed. You can then use that as a guide for deciding whether to stick with your current bank or shop around for a new one.

Recommended: Guide to Practicing Financial Self-Care

The Takeaway

Having a checking account can make managing your financial life easier, but it’s important to make sure you’re using it the right way. Avoiding common checking account mistakes and developing good banking habits can help you use your account to its full potential. Doing so can also help you earn more interest and pay fewer or lower fees.

If you’re ready to try a new banking experience, you might consider opening an online checking and savings account with SoFi. You can enjoy the convenience of saving and spending in one place, plus you’ll get benefits like paying no account fees and enjoying a great APY on deposits, which can help your money grow faster.

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

What is the worst checking account mistake that I need to avoid?

The worst checking account mistake may simply be choosing the wrong account or the wrong bank. When you fully understand what you need a checking account for and what kind of features you’d like to have, that can make it easier to find the right banking option that’s convenient and low-cost.

What to do if the bank makes a mistake?

If your bank makes a mistake with a deposit, bill payment, or any other transaction, it’s important to contact the bank right away. You can explain what you believe the mistake to be so the bank has an opportunity to correct it.

What are the disadvantages of these banking mistakes?

Making banking mistakes can cost you both time and money. You may end up spending more time than you’d like to managing your accounts. Or you might overpay banking fees if you’re not paying attention. Correcting any banking mistakes can help you avoid those scenarios.

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SoFi Checking and Savings is offered through SoFi Bank, N.A. Member FDIC. The SoFi® Bank Debit Mastercard® is issued by SoFi Bank, N.A., pursuant to license by Mastercard International Incorporated and can be used everywhere Mastercard is accepted. Mastercard is a registered trademark, and the circles design is a trademark of Mastercard International Incorporated.

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

Eligible Direct Deposit means a recurring deposit of regular income to an account holder’s SoFi Checking or Savings account, including payroll, pension, or government benefit payments (e.g., Social Security), made by the account holder’s employer, payroll or benefits provider or government agency (“Eligible Direct Deposit”) via the Automated Clearing House (“ACH”) Network every 31 calendar days.

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.

See additional details at https://www.sofi.com/legal/banking-rate-sheet.
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.

Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.

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The main difference between a commodity vs. security lies in what you own. Commodities are raw materials and basic goods, while securities represent an ownership stake (e.g. stock) or a debt obligation (e.g. bonds).

As such, investing in commodities and securities can offer two different paths to diversification.

Both commodities and securities can be traded on market exchanges. Between the two, commodities are typically categorized as alternative investments to the traditional array of stocks, bonds, and cash many investors hold.

Understanding Commodities

What are commodities? The Commodity Futures Trading Commission (CFTC) recognizes three categories of commodities:

•   Agricultural

•   Natural resources

•   Financial instruments

In simple terms, commodities are raw materials typically used in the production of other goods. Commodities are considered a type of alternative investment because these products — whether oil, corn, or copper — don’t move in sync with traditional stock and bond markets, and may provide portfolio diversification.

Types of Commodities

Broadly speaking, commodities may be classified as hard or soft. Hard commodities are mined or extracted, while soft commodities are produced through agriculture.

Examples of agricultural commodities include wheat, soybeans, corn, and livestock. Natural resource commodities include gold, silver, copper, and timberland investments. Financial instruments include U.S. or foreign currencies, or options and futures contracts that invest in an underlying commodity.

The Commodity Exchange Act (CEA) regulates the trade of commodity futures in the U.S. Trading futures commodities must generally be done through a commodity exchange, with some limited exceptions. The CEA also enables the CFTC to regulate the commodities industry.

Recommended: What Is a Gold IRA?

Understanding Securities

Now, what are securities? The term securities refers to a broad range of investments where there’s an expectation that value or profit will be returned to the investor. Examples of securities include:

•   Stocks

•   Bonds

•   Mutual funds and exchange-traded funds (ETFs)

•   Mortgage notes

•   Promissory notes

•   Limited partnerships

•   Oil and gas interests

•   Debentures

•   Investment contracts

Stocks and bonds are among the most commonly traded securities. When you buy shares of stock you’re getting an ownership stake in the underlying company. Should the value of your shares increase you could sell them at a profit.

Bonds are a debt obligation between the bond issuer and investors. When you buy a bond, you agree to let the bond issuer use your money for a certain period. During that time you’ll earn interest, and when the bond matures you can reclaim your original investment.

Certain types of financial instruments are excluded from this list. Checks, bank accounts, and traditional life insurance policies don’t meet the definition of a security.

How Securities Are Regulated

The Securities and Exchange Commission (SEC) regulates securities trading in the U.S. Some of the most significant laws relating to securities include:

•   The Securities Act of 1933

•   The Securities Exchange Act of 1934

•   Investment Advisers Act of 1940

•   Sarbanes-Oxley Act of 2002

•   Dodd-Frank Wall Street Reform and Consumer Protection Act of 20105

Many securities are publicly traded on market exchanges. The New York Stock Exchange (NYSE), for example, is the world’s largest stock exchange. Securities that do not trade on an exchange may be traded privately or over the counter. Over-the-counter trading relies on a network of broker-dealers to complete the sale or purchase of securities.

Comparing Commodities and Securities

Commodities and securities can be used to achieve different goals in a portfolio. Both allow for diversification but they differ in how they work, what you’re trading, and the associated risks and rewards.

Here’s a simpler way to think of the difference between a security vs. commodity. Securities often represent the end product, while commodities are the building blocks of that product.

For example, take a company that produces computer chips. If you invest in the precious metals used to make computer chips (e.g. gold, silver, platinum), you’re investing in commodities. If you buy shares of company stock, those are securities.

Here are some of the important things to know if you’re weighing security vs. commodity trading.

	Commodities	Securities
Nature of the investment	Raw materials and basic goods	Stocks, bonds, mutual funds, investment contracts
Trading mechanism	Futures contracts and options can be bought and sold on a commodity exchange; commodity mutual funds and ETFs can be traded on a stock exchange	Publicly traded stocks and bonds can be bought and sold on stock exchanges
Potential Benefits	Portfolio diversification, potentially higher returns, inflationary hedge, potential insulation against market volatility	Potential gains through active trading, potential for long-term capital appreciation, potential for passive income from dividends
Potential Risks	Supply and demand, weather/climate conditions, geopolitical events can influence commodity pricing	Supply and demand, investor sentiment, economic conditions, interest rates, and company health can influence stock and bond prices
Regulatory body	Commodity Futures Trading Commission	Securities and Exchange Commission

Recommended: What Is a Silver IRA?

Investing in Commodities vs Securities

Purchasing physical commodities isn’t realistic for the average investor, as doing so requires you to store them (or pay for storage) until you’re ready to sell. Instead, commodities are typically traded through one of the following:

•   Options contracts

•   Futures contracts

•   Commodity mutual funds and ETFs

•   Hedge funds (often the domain of high-net-worth investors)

Options and futures contracts are derivatives, meaning their value is determined by an underlying investment, i.e., the commodity you’re trading. Commodity funds and ETFs can offer exposure to a basket of investments, which may include individual securities.

For instance, rather than trading oil futures contracts, you might purchase an ETF that holds gas stocks. Or you could buy individual shares of energy stock if you prefer.

With securities, you have some of the same avenues for investing. You can purchase stand-alone stock shares or individual bonds. Mutual funds, an array of index funds, and ETFs can offer broad diversification. You could also trade stock options if you’re comfortable with speculative investments.

Whether it makes sense to choose a security vs. a commodity for your portfolio can depend on your risk tolerance and objectives.

Portfolio Diversification With Commodities and Securities

Commodities can offer exposure to alternative investments beyond traditional stocks and bonds. Thanks to options, contracts, and commodity funds you don’t need to purchase physical commodities. You can select which areas you’d like to target, based on whether you prefer hard vs. soft commodities.

You might choose to focus on a single category, such as agriculture. Or you might spread your investment dollars across agricultural commodities, natural resources, and financial instruments for a more well-rounded approach.

Diversifying with securities often means finding the right mix between stocks and bonds. Your optimal asset allocation may depend on your age, your time horizon for investing, and how much risk you’re comfortable taking. Within each securities category, you can decide how to invest based on:

•   Whether you’re looking for a quick profit vs. longer-term gains

•   Your preference for earning passive income from dividends or interest

•   How much risk you need to take to achieve your goals

All investments carry some risk, though some are riskier than others. Commodities tend to veer toward the riskier side which is important to remember when deciding how to allocate your portfolio.

The Takeaway

The main difference between a commodity vs. a security lies in what you own. With commodities, you’re most often trading futures or options contracts for an underlying good, such as pork bellies, oil, or aluminum. With securities, you’re typically buying stocks or bonds, or derivatives contracts.

Ready to expand your portfolio's growth potential? Alternative investments, traditionally available to high-net-worth individuals, are accessible to everyday investors on SoFi's easy-to-use platform. Investments in commodities, real estate, venture capital, and more are now within reach. Alternative investments can be high risk, so it's important to consider your portfolio goals and risk tolerance to determine if they're right for you.

Invest in alts to take your portfolio beyond stocks and bonds.

FAQ

What is the difference between a security and a commodity?

The main difference comes down to what you’re investing in. With commodities, you’re most often trading futures or options contracts with an underlying raw material or good, such as pork bellies, oil, or aluminum. With securities, you’re typically buying shares of a company or funding bonds with the expectation of earning interest.

Can a commodity become a security?

A commodity can become a security if it meets the definition of an investment contract under the Howey Test. This test, which was formulated through a 1946 Supreme Court decision, defines an investment contract as being an investment of money in a common enterprise, with the reasonable expectation of profits due to the managerial efforts of others.

Is gold considered a commodity?

Yes, gold is considered a commodity. In terms of its uses as a raw material, gold is often a key element in jewelry production and electronics manufacturing. Historically, gold has also been used as a form of currency and is a form of legal tender in the United States, but it is not considered a security.

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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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