How much money should you keep in your checking account?
The obvious answer is enough, but not too much. But why, and how do you know how much this is?
Smart money managers don’t keep more money in their checking accounts than necessary, because checking accounts do not earn much interest. The money you keep in your checking account is used to pay bills, and extra money — should you have such a thing — is traditionally stored in a savings account, where the interest, and the balance, is higher.
But since even savings account interest is very low, does it really make a difference whether you keep your extra money in a checking or a savings account?
Bank of America has an online tool in which you can put in your ZIP code and it will tell you interest rates in your area as of that day. On March 11, in the Washington, D.C. area, the interest rate on checking accounts was approximately 0.03, two-tenths of a percentage less than a savings account.
This was based on an average daily balance of less than $2,500, however. If you keep more than that in your checking account, the interest is — still 0.03 percent! The document goes on to outline how if you reach certain tiers — by keeping a half-million dollars in your account — you can earn up to 0.06 percent.
CNBC reports that 67 percent of millennials have less than $1,000 in their savings accounts, and half of these people have a balance of 0. Let’s say that among those astute (or lucky) few who keep some money in their checking account, that they keep $1,000 for one year. Using this online interest calculator and plugging an interest rate of 0.03 percent, they would earn 30 cents in interest by the end of the year.
If they instead kept that money in a savings account paying 0.05 percent a year, they would have 50 cents in interest at the end of the year. Although that is an increase of 60 percent, 60 percent of almost nothing is still nothing.
So when you ask how much money you should keep in your checking account vs. how much you should keep in your savings account, based on interest alone, the answer is that it doesn’t matter.
However, there are other considerations to how much money you should keep in your checking account besides interest.
One of these is fees.
Bank Fees Add Up Quickly
There are all kinds of fees you might consider outrageous: the fee for driving 45 in a 35-mph zone, the fee for the ticket you bought to a concert or sporting event, the fee you pay to your HOA for doing little more than pester you about the length of your grass.
But the fee for bouncing a check is always grating. It can even bring some to tears, depending on your financial situation and what kind of day you’re having.
The truth is that people write fewer checks today than ever before. One reason is that so much bill-paying is automated. You still have to pay the electric company, you just don’t write out a paper check to them. Instead, you sign up for an automated payment to come out of your checking account.
But it’s the same process, and the check can bounce the same way. If you don’t have enough money in your account to pay all the ACHs you have authorized, some checks will bounce.
Your bank will likely charge you about $30 for this mistake, and whoever or whatever you wrote the check to will probably whack you for another $30. Why? Is it to pay for the time they take to visit the bank a second time in an effort to get their money? Probably not. The de facto loan they extend to you during the time they wait for you to deposit money? Maybe. But as the Los Angeles Times recently reported in a story about ridiculous bank fees, it could be the fee their own bank charges them for receiving a bad check.
But what if you have enough money in your checking account to pay all your bills? It still might not be enough, according to your bank.
The LA Times story says that in 2009, the banking industry levied $41 billion in fees on its customers. Among these is the dreaded “low-balance fee,” which could cost you up to $25 a month. Some smaller banks, credit unions, and online banks do not charge such a fee.
So what should you do? How much money should you keep in your checking account?
Being Informed Is the First Step
First, find out if your bank charges a low-balance fee, and if so, what your balance must be to avoid this fee. If it is unrealistic for you to be able to achieve that balance most months of the year, then you would probably be better off with another bank that does not charge this fee.
Second, plan to keep enough of a cushion in your account so that you don’t bounce any checks. There is no way to calculate this exactly, but a good predictor is to keep $1,000 more than your largest bill. So if your mortgage is $2,200 per month, keep at least $3,200 in there in the weeks leading up to the payment.
Make Better Investments
If you have a fairly large surplus of cash, you should consider an investment vehicle with better returns than either a savings or a checking account. Some accounts that may grow faster and offer tax breaks are 401(k) plans, IRAs, and 529 accounts. But remember, this money is not readily accessible — if you need to withdraw it in an emergency, you will pay a penalty.
Certificates of deposit are another consideration. They pay more in interest than a savings account, although not much more, about 2.5 percent.
When you’re asking yourself how much money should you keep in your checking account, think about how a higher average balance is sort of an insurance policy — insurance against mistakes and steep fees.