By the end of this four-post series, you’ll have a map for a hassle-free financial system that puts your day-to-day money issues on autopilot, letting you worry about more important stuff like developing your career, earning more money, and enjoying life.
Last week, we talked about how budgets are a pain in the ass to maintain and how they can actually hold you back from getting your money in order. I offered a way to minimize budgeting, doing just enough to know your expenses while eliminating the need to worry about how much is left in the coffee budget this month.
Today, we’ll cover an important prerequesite to putting your finances on autopilot:
The bank account buffer.
A bank account buffer is my name for what other people may call a cash cushion, mini emergency fund, or back-up savings. And it’s simply this: some extra cash in your checking account. (Need help choosing a bank account?)
When you have a bank account buffer in place, you don’t have to worry that a mistimed latte on your debit card will overdraw your account and trigger a $35 overdraft fee. More importantly, you’re free to start putting bills and investments on autopilot. And as we’ll discuss in the upcoming posts, when things are on autopilot you will worry less, spend less time managing your money, and keep yourself from meddling with your savings and investments.
WHY BUFFERS MATTER: AN ANALOGY
Modern aircraft can basically fly themselves. Although your pilots will likely land the plane by hand, they will definitely punch on the autopilot for much of a long flight across the Atlantic.
Two factors make autopilot safe to use during cruise flight:
- A predictable set of circumstances. The pilots can, for example, set the plane to fly a certain altitude and heading for several hundreds of miles while air traffic controllers help ensure they won’t run into other planes.
- Altitude. At 35,000 feet above the Earth, there is a plenty of time to react if things go wrong.
Planes fly at certain altitudes for many reasons—in part, fuel efficiency—but the higher they go, the more time pilots have to recover and land should things go wrong.
You can think of your money the same way.
When you’re living paycheck to paycheck, you’re flying close to the ground. One bad bump and you can crash: wracking up overdraft fees or going into debt.
You wouldn’t dare put your money on autopilot in this situation. How can you set your rent to pay automatically on the first of the month if you’re not sure there will be enough in the account each month to cover it?
But imagine if you had an extra $1,000 in your checking account that serves as a buffer between you and an overdraft fee. You don’t spend it, but it’s there to protect you in case your bank debits your rent payment a couple days before you get paid. It’s like an aircraft having an extra 20,000 feet of altitude.
So a bank account buffer is a good thing. But how is different from an emergency fund? And how much do you need?
BANK ACCOUNT BUFFERS VS. EMERGENCY FUNDS
An emergency fund—that separate savings account stuffed with six months expenses or more—is a vital part of financial stability. But it comes later.
A bank account buffer is a starting point. A bank account buffer:
- Protects against minor cash flow fluctuations, like paying rent a few days before your paycheck deposits.
- Is equal to 25% – 50% of one month’s expenses.
- Stays in your checking account.
An emergency fund:
- Protects against big expenses and loss of income.
- Is equal to at least six months of expenses.
- Should be kept in a separate, interest-bearing savings account.
HOW BIG A BUFFER DO YOU NEED?
In the past, I’ve recommended $500-$800 for a bank account buffer. For most people, this is enough. But your bank buffer should be whatever makes you comfortable.
If you have predictable income and expenses and track your spending to the penny, you don’t need much of a buffer. If, however, your expenses or income vary from month to month or you simply don’t want to worry about your bank balance very often, a larger buffer is in order.
Once you know your average monthly expenses, you can build a buffer of between 25% and 50% of your monthly expenses. So if you typically spend $2,500 a month, start with a buffer of $625. If you want more than that, gradually work up to a $1,250.
There is a sweet spot. You don’t want to build your cash cushion too big because that money could be at work for you in some other way. Although interest rates are dreary now, one percent in a high yield savings account is better that zero percent in a checking account. (As an alternative, you can look into interest-bearing checking accounts.)
And yes, you should have a bank buffer even if you’re in credit card debt. But keep the buffer no bigger than necessary. Then, funnel all extra money to paying down your credit card balances.
Keeping $500-$1,000 of extra cash in your checking account (a “bank account buffer”) helps protect against overdraft fees and serves as a mini emergency fund when small, unexpected expenses pop up. Building this buffer will enable you to begin putting your money on autopilot, reducing stress and making it easier to reach financial goals.
YOUR ACTION ITEM
If you don’t already have one, build your bank account buffer in the next 30 days.
Putting an end to the paycheck-to-paycheck lifestyle is the best thing you can do for your finances. And it will feel frigging phenomenal.
With some hard work, you can get there 30 days or less. Sell some stuff you don’t use. Cut back on luxuries, if only for a month. If you’re paying extra toward debt or making investment contributions, skip a month; the buffer comes first.
If you already have a bank account buffer, how do you structure it? How much of a cash cushion do you keep?