While your checking account is designed for everyday spending, keeping too much there can limit your potential to earn investment income. Many individuals are unsure how much money they should keep in their checking account versus a savings account or other investments.
So, how much should you keep in your checking account, and when is it time to move funds elsewhere? Here’s a guide to help you find the right balance.
The Ideal Amount to Keep in Your Checking Account
Checking accounts are meant for daily transactions, like paying bills, paying your credit cards, paying your rent or mortgage, or taking out cash at an automated teller machine (ATM).
Unfortunately, a checking account typically pays no interest income, so keeping an unnecessarily large balance of funds in a checking account yields zero percent return on investment (ROI).
For example, assume John Doe has a checking account with $50,000 of cash. The checking account earns zero interest on the account balance. At the end of the month, John’s ROI on the $50,000 cash in his checking account is zero.
Alternatively, assume John transferred $45,000 to a savings account that earns 3% interest per year, compounded monthly. He keeps only $5,000 cash in his checking account. At the end of the year, John’s $45,000 cash investment in a savings account earns him $1,368.72 of interest income. John now earns some investment income by transferring cash to an interest-bearing account rather than keeping it all in a checking account.
The Rule of Thumb is 1 to 2 Months of Regular Cash Needs
Most financial experts recommend you keep one to two months of cash needs in your checking account. For example, these regular monthly cash needs include payments for your rent or mortgage, utility bills, credit card payments, and insurance.
If you keep at least two months of cash inside the account, it ensures that you have enough to cover those regular cash needs without having to worry about overdrafts or falling below the minimum account balance to avoid monthly maintenance fees.
One of the most important things for you to keep in mind is liquidity. Quick access to cash is crucial for emergencies and unexpected expenses. The quickest way to access your cash is in a regular checking account rather than transferring funds from a savings account or selling investments in a brokerage account. When you build your family budget, the quick access to cash serves as your family emergency fund.
When to Transfer Excess Funds to a Savings Account
Once you fund your checking account with enough money for one or two months of cash needs, you can now transfer any excess funds into a savings or brokerage account to earn some investment income.
Why a Regular Savings Account?
Savings accounts are relatively liquid, meaning you can access your money quickly without the delays you might experience with stock or bond investments, a certificate of deposit (CD), retirement accounts, or other less liquid assets.
While interest rates on savings accounts are generally low, they still provide a safe place to grow your excess cash compared to simply letting your money sit in a regular checking account that pays no interest income.
Why Use a High-Yield Savings Account?
For better returns, consider transferring your funds to a high-yield savings account (HYSA) rather than a traditional savings account. These HYSA products often provide much better interest rates than conventional savings accounts with a bank.
Low-yield savings accounts are generally found in classic brick-and-mortar banks. These banks have an actual retail location where you can visit the bank in person. Because these banks have high operating costs due to maintaining physical locations, they cannot offer higher yields on their savings accounts.
In contrast, a savings account with a bank that is not a brick-and-mortar operation can offer higher returns on investment, making them a high-yield savings account. For example, American Express Bank offers high-yield savings account products with interest rates that far exceed the rates offered by traditional banks. American Express generally does not operate physical branch locations for customers to visit.
When to Transfer Funds to a Brokerage Account
Consider moving additional funds into a brokerage account once your checking account has sufficient cash for short-term needs. Here, you can invest your money in stocks, bonds, mutual funds, or an exchange-traded fund (ETF) to earn higher investment returns.
When Should You Invest?
Only invest once you’ve established a solid emergency fund. Money in a brokerage account is subject to market risks, meaning its value can fluctuate up and down quite quickly, so it’s not ideal for emergencies or short-term cash needs.
Use a brokerage account to invest money for long-term goals like retirement, buying a house, or funding your child’s education. The stock market generally provides better returns than savings accounts in the long run, though it carries more risk.
Since the Standard and Poor’s 500 (S&P 500) was introduced in 1957, its annual return has averaged approximately 10% each year through the end of 2023.
Conclusion: Maximize Your Money’s Earning Potential
The amount of money you keep in your checking account should cover immediate expenses and serve as a buffer for upcoming bills. However, you should transfer any extra funds beyond this to a high-yield savings account or a brokerage account for a greater ROI. Balancing liquidity with growth ensures that your money works for you.