If you’re no longer living paycheck-to-paycheck, it’s time to get that money out of your everyday transaction account.
Why? Because although some everyday accounts do offer interest these days, your cash will probably earn more money for you in a savings account.
Right now I try to maintain an everyday account balance of $4000 — a number designed to cover a little more than my typical $3500/month expenses. I also maintain a savings account balance of $14,000. This serves as a four-month emergency fund and provides a buffer against freelance income lulls or late payments.
I have a separate savings account where I stash money to put towards estimated taxes, and every other dollar I earn gets invested. As Laura Munoz explains in The Financial Diet, this is a life-changing money move:
[...] once I realised I didn’t need to pay for everything with my debit card, I also realised that money sitting in a debit account just, well, sits there. It doesn’t earn interest and it’s not working for you, so there’s no real reason to keep more than a healthy buffer there in case you need to take out cash in a pinch. Now my cash on hand sits in two places: a high-yield savings account where it earns interest without any risk, and another savings account that’s invested in the stock market, where there’s more risk and reward potential.
Yes, putting your money in the market — even in a money market account — comes with some risk. This is why personal finance experts suggest keeping your emergency fund in cash, not in investments. Since market crashes are often associated with recessions, keeping some of your money in a savings account can help protect you if your investments plummet right before you get laid off, for example.
Keeping your extra money in an everyday account can also protect you from a market crash, of course — if that money is still in the everyday account when you need it. If you’re the kind of person who uses your everyday account balance as a way of determining how much you can spend, you could end up spending everything in the account. Limiting the amount of money in your everyday account makes you more aware of how much you’re spending, and how often you have to transfer money from savings to cover an everyday expense (or pay off a credit card bill).
So keep the bare minimum in your everyday account, no matter how much you’re earning. Think of it like a large-scale version of the envelope system, with your everyday account as a giant envelope that contains all of the money you get to spend that month.
Then put the rest of your earnings in a place where they can earn money for you — because that’s one of the best ways to make your net worth grow.