One of the first things you learn as an investor is the value of diversification. Not keeping all your eggs in one basket means that a bad turn for one of your investments won't ruin all of your future plans. The odds are good that not all of your investments will fall in value at the same time, thereby dampening the effect of any downturns on your overall portfolio.
However, some people apply the concept of diversification beyond its intended scope, applying it not only to owning different types of investments, but also to having several different accounts with various financial institutions. Unlike diversifying among asset classes, having a large number of financial accounts open at the same time usually has few benefits and some substantial pitfalls. And while owning shares of Wells Fargo (NYSE:WFC), US Bancorp (NYSE:USB), and Washington Mutual (NYSE:WM) may make sense in your portfolio, having bank accounts at all three probably won't get you anything but a lot of hassle. As 2007 begins, take a close look at your finances to see where you may be able to simplify the way you save, spend, and invest.
Bank accounts from the past
If you've ever moved from one city to another, you may have left a bank account open in your old city. After all, when you're in the middle of moving all your worldly possessions hundreds or thousands of miles, there are many more pressing issues on your mind than closing your bank account. Furthermore, if you don't have everything settled in your new city yet, you'll want to keep your old account active so that you can write checks and pay bills until you get new accounts established near your new home.
However, once you've completed your relocation, it usually makes sense to go ahead and close those old accounts. Unless your old bank has branches in your new location, you probably won't ever use your old bank accounts. Moreover, if your old bank requires you to keep a minimum balance or pay monthly service charges, you may have to keep a decent amount of cash in your old account, even if you never use it. Of course, if you plan to visit your old town on a regular basis, keeping that account open can make sense, giving you access to fee-free ATMs and ready cash. For most people, though, closing the account is the smart move.
A deck of credit cards
As a young and savvy consumer, your first credit card offer is a mark of success, an indication that you've made it in the financial world. As you receive increasing numbers of such solicitations in the mail, it's tempting to take advantage of them all, in order to see how much you can have. Even if you never plan on using all of them, just having a wallet full of credit cards feels like a mark of financial success.
Getting too many credit cards, however, is usually a big mistake. The scores that credit rating agencies calculate, based on your credit history, can fall if the agencies determine that you have more open credit card accounts than you should. More importantly, juggling all those credit cards can be both time-consuming and expensive. When you have five or six credit card bills coming in every month, it's easy to forget whether or not you've paid all of them, which can lead to higher finance charges, late fees, and further damage to your credit rating.
In addition, when you move, the more credit card accounts you have, the more phone calls you have to make to change your address. Even if you never use some of your credit cards, failing to change your address can lead to identity theft problems, since whoever moves into your old home could receive a letter that contains your confidential information. For most people, it's generally smarter to pick two or three of the cards you use the most, then get rid of the rest.
Review your retirement plans
Retirement plans from former employers are another area in which people often neglect to clean up old accounts. If you participated in a former employer's 401(k) plan, you may still have assets in the old plan even after you quit.
With retirement plans, there are sometimes valid reasons for keeping an old account open. For example, some retirement plans allow participants to invest in company stock that is generally unavailable to outside investors. If you own company stock in your old 401(k) and believe that it's a good investment, you may want to keep your old account open in order to hold the stock. Also, some retirement plans offer more liberal distribution rules than rollover IRAs, such as the right to take withdrawals at an earlier age.
Keep in mind, however, that if your account is relatively small, your employer may have the right to force you to close out your retirement plan. The current limit is $5,000; if your account is worth less than that, then your employer has no legal obligation to allow you to keep your account. With small accounts, the biggest danger is that your former employer will simply cut you a check for the balance of your retirement plan. Although you may not immediately realize it, this check represents an early distribution of plan assets, which not only creates potential income tax liability, but also may incur a 10% penalty for early withdrawal. The best way to avoid having to deal with this is to request that your former employer roll over your plan assets directly into an IRA. For IRS purposes, the rollover isn't treated as a distribution, so you won't owe tax or penalties.
Finances are complicated enough without making things more complex than they have to be. By closing out unnecessary accounts, you can run your finances more smoothly.
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Fool contributor Dan Caplinger closed three old bank accounts last year. He doesn't own shares of the companies mentioned in this article. Both Washington Mutual and US Bancorp are Income Investor picks. The Fool's disclosure policy is simple.
