Here’s a common question from new readers:
“What’s the number one most important thing I can do to improve my financial situation quickly?”
After years of helping people get inspired about taking control of their money, I no longer have to think about my answer — it’s so obvious.
Get a bank account buffer.
Whether you’re 15, 25 or 65, if you’re having trouble with your money and want to improve, the very first step you should take is to build a bank account buffer.
A bank account buffer is my name for what other people may call a cash cushion, mini emergency fund, rainy day fund or back-up savings.
A bank account buffer simply some extra cash in your checking account.
When you have a bank account buffer in place, you don’t have to worry that a poorly timed Starbucks break you charged to your debit card will overdraw your account and trigger a $35 overdraft fee.
More importantly, with a bank account buffer, you can feel more comfortable about 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 money and save yourself from emotional investing decisions.
Why bank account 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.
- Lot of altitude. There are several reasons airliners fly as high as they do — wind direction and fuel efficiency matter — but higher is also safer. Altitude is a buffer. At 40,000 feet, an aircraft has distance from even the highest terrain and the altitude gives pilots 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: collecting overdraft fees or going into debt.
You would be rightly wary of putting 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?
A bank account buffer vs. an emergency fund
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 between one and two weeks of income.
- Stays in your checking account.
An emergency fund:
- Protects against large unexpected expenses and loss of income.
- Is between six and nine months of expenses.
- Should be kept in a separate, interest-bearing savings account.
How big should your bank account buffer be?
Simply put, your bank account buffer should be the greater of:
- Between $500 and $1,000 or
- At least one week’s take-home pay and up to two week’s take-home pay
For example, if you earn $35,000 and take home $532, after taxes, each week, you would want to have at least an extra $532 in your checking account and up to $1,064.
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.
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, 1 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.
How to build a bank account buffer
Perhaps you’re thinking that a bank account buffer sounds good, but if you’re living paycheck-to-paycheck, you can’t imagine where that money will come from.
To be sure, the less money you have left over after each paycheck, the more vital it is to create a bank account buffer, but it’ll also be more difficult. To do it, you’ll have to:
- Cut bank on expenses for a few months until you’ve saved the money
- Earn more at work, either by working more hours or getting a raise
- Earn money on the side
Starting a side hustle has always been my preferred method because I know just how difficult and miserable it is to squeeze more savings out of an already strapped budget. But you don’t even have to take an extra job or start a business to earn enough money to create a bank account buffer: It could be as simple as having a yard sale or selling a couple of high ticket items online you don’t use anymore.
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?