First, an easy question: How much money do you have in your checking account? The second question is harder: How much money do you need in your checking account? Many people default to storing excess savings in their checking account. It is where their paychecks and income are deposited and the general location from which they pay bills. The drawback to having excess savings stored in a checking account is that it often earns little or no interest. This means that the money in a person’s checking account is slowly losing value due to inflation. An alternative to this requires establishing a reserve account to back-up the checking account, where the reserve account will earn interest, decreasing the pain of inflation and providing at least some growth.
The Purpose of a Checking Account
The purpose of a checking account is to provide individuals with ready access to safe, electronically stored funds which can be used pay to bills. Generally speaking a checking account is FDIC insured and extremely liquid, allowing for the immediate usage of the funds therein. These accounts are not intended to be a location for the long term store of value. Banks often provide individual customers with services such as check writing and debit cards to access their funds, but in turn do not provide meaningful interest payments on checking account balances. As the purpose of a checking account is to provide short term, highly liquid cash to pay bills a three month time horizon can be a good starting point for a checking account funding level.
Establishing Average Expenses
To accomplish this, an individual can look at their spending or consumption rate of their checking account on a monthly basis. Determine a monthly average, and then multiply that number by three. The resulting amount can be useful benchmark for how much to keep in a checking account. Anything beyond this amount can be pushed into a reserve account, or what some would call an emergency fund. As the reserve account is not intended for day-to-day usage, such as debit card transactions and paying bills, it can be put to work earning interest. A money Market account, for example, can be a good vehicle for a reserve account as it will allow the money to grow, while still remaining liquid and accessible.
Benefits of a Reserve Account
Besides just earning interest, which is reason enough to establish, a reserve account can also provide other benefits. First, the reserve account can act as a buffer, providing a quick infusion of cash when unexpected expenses occur. This alleviates the need to tap resources that are otherwise earmarked for long-term goals such as retirement. Second, the reserve account can act as a medium-term saving goalpost. An example here would be saving for a down-payment on a car, where the funds are expected to be spent, within the next several months, but still not immediately. In this case, it would be beneficial to earn interest while approaching the expense. Finally, a reserve account, for some, can act as a psychological spending barrier. Limiting the funds available for day-to-day purchases may cause some to then curtail their day-to-day spending. By keeping some of their funding in a reserve account and requiring even a small extra step to access it, it may support the efforts of those looking to limit their own spending.
Optimization
The optimal amount to keep in a checking account, will vary based upon situation, comfort level and individual circumstances. It is important to consult with a professional when determining the correct level and investment vehicle for checking and reserve accounts. Keeping all of your money in a checking account is likely not optimal. A reserve account is one method for leveraging the money you have today, for more tomorrow.