Where do you put all the money that you earn from your paycheck?
If you’re like most people, then the answer is that it most likely goes straight into your checking account. This is pretty typical considering that those funds are turned right back around to pay for your regular monthly expenses such as the mortgage or rent, food, utilities, insurance, credit cards, etc.
So what happens when there are months when your bills exceed your income? Does it make sense to let your savings accumulate in a place where it will earn no interest at all? How much is “too much” to have in there before you should start looking for other ways to put it to use?
In this post, we’ll explore how much money should be in your checking account and help you determine the optimal amount.
Why Too Little Can Be Dangerous
According to a survey by LendingClub, approximately 64 percent of Americans are living paycheck to paycheck. This is unfortunate because it means that they’re just barely bringing in enough money to cover their living expenses each month.
When it comes to your checking account, this can be a dangerous game of chicken to play with the bank. When a person writes a check, pays by debit card, or has an automated (ACH) withdrawal made to pay a bill, they’ll be charged one of two fees if they don’t have enough money in their account:
- Overdraft fee – The bank decides to approve your transaction but charges you a penalty for not having the funds to cover it
- Non-sufficient funds (NSF) fee – The bank decides to reject your transaction and charges you a penalty in the process
Although each bank is different, these fees are generally around $35 per instance.
The scary thing about these fees is that you can be charged per transaction. For instance, let’s assume your checking account balance is $0 and you decide to make a purchase with your debit card. Also on that same day, your rent was due and an ACH withdrawal was scheduled to take place. Most likely you’d get an overdraft fee for the smaller purchase but perhaps an NSF fee for the larger second transaction.
What’s worse is that these are not one-time fees. With an overdraft fee, you’ll be charged each day that you don’t have enough money in your account to cover the expense. With NSF fees, banks may try to cash the same check multiple times over the next few days which will result in more penalties each time it’s denied.
Furthermore, when it comes to transactions that result in an NSF fee, this can cause problems for the expense that you were trying to pay. For instance, if an automated payment to your credit card was denied, now on top of an NSF fee from the bank you’ll also likely have a late payment fee from the credit card company and potentially a negative mark on your credit report.
Clearly the best solution is not to ever let your checking account balance get too low. Keep at least some level of a safety buffer or a minimum “floor” in there at all times. So how do you determine how much?
How to Determine the Optimal Amount for Your Checking Account
There can be many good answers to how much money you should have in your checking account at all times. This will depend greatly on your own personal preferences, comfort, and how much your finances permit.
A good rule of thumb is to shoot for at least one month’s worth of living expenses. For example, if you spend $5,000 per month, then you’ll want to make sure that your checking account is never less than $5,000 at all times.
If you’re not sure how much money that is, then a good way to figure it out is to start tracking your finances. This can easily be done using an app like Buxfer. Buxfer connects to your bank and credit card accounts and syncs all the transactions into one, easy-to-read dashboard. You don’t have to do anything while the app collects all of the necessary data in the background.
After using Buxfer for a month or two, you’ll get a realistic picture of what your expenses look like. You’ll then be able to use this information to determine how much your checking account floor should be.
Building In an Emergency Fund
Having a small safety buffer is nice, but what about those times when you receive a larger-than-expected medical bill or have to make a substantial out-of-pocket purchase? These things happen from time to time and can quickly put you right back into the danger zone of incurring overdraft or NSF fees.
To better protect yourself, you may wish to increase your checking account target to at least two times your monthly expenses. For instance, going back to our earlier example of spending $5,000 per month, your new checking account target should now be never less than $10,000 at all times.
Take note that this can be thought of as part of your emergency fund. Emergency funds are generally separate cash accounts with the equivalent of three to six times your monthly expenses stashed away. If your checking account already has two times available, then you’re almost right there in that range.
When You Have Too Much
Once you have one to two times your living expenses plus some additional money saved for an emergency fund, it won’t be to your benefit to have any more than this in your checking account.
The reason is that checking accounts don’t pay any interest or give you any incentive. The money just literally sits there doing nothing. In fact, given that inflation is always eroding the value of your money every year, you’ll technically be losing money.
Instead, the better use of excess funds is to invest them. Buy stocks, mutual funds, ETFs, or anything else you feel comfortable putting your money into in hopes to make a reasonable return. For example, index funds are some of the most commonly purchased investment products and are known to return an average of around 10 percent per year when invested for the long-term (i.e., 10 years or more).
Protect Your Finances
In summary, don’t let your funding get so low that you’re in danger of becoming overdraft. Protect yourself by making sure you’ve got at least one to two months’ worth of living expenses in your checking account at all times. Beyond that, be sure to put your dollars to work by investing them for sustainable long-term growth.
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