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The Bank Account Buffer (Building a No-Hassle Money Management System, No. 2)

Having a bank account buffer -- a cash cushion in your checking account that you never spend -- will start to alleviate your money worries right away.

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.

RECAP

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.

Your Thoughts

If you already have a bank account buffer, how do you structure it? How much of a cash cushion do you keep?

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About David Weliver

David Weliver is the founding editor of Money Under 30. He's a cited authority on personal finance and the unique money issues we face during our first two decades as adults. He lives in Maine with his wife and two children.

Comments

  1. I completely agree with the idea of a buffer being a big savings, but what are your feelings on “Overdraft” lines of credit, or “Cash Reserves”? Lines of credit attached to checking accounts for this exact purpose. I have a $1,000 LOC at my credit union that has maybe been used once in the past year for basically this exact purpose- my mortgage came out a day before I got paid. I got paid, and immediately transferred the funds to pay off my LOC. I paid just a few cents in interest. The APR attached is under 10%.

    I basically asked myself “What’s the largest bill that could come out a day or two early?” and that’s the amount I like as a cushion, or in this case- the limit for my LOC.

    • David Weliver says:

      Yes these overdraft LOCs seem like a perfectly acceptable alternative provided there are no annual fees. As you point out, with a low APR and if you redeposit money quickly every time, you’re looking at only a few cents charge.

      There are similar products where banks will “sweep” money from a linked savings account or loan account to your checking in the event of an overdraft and charge a lesser fee, say $5 instead of $35, for the overdraft. This is, of course, better than having nothing at all, but I’d take my own buffer over one of these plans because even $5 fees add up.

  2. I ended up with a nice big buffer in my checking account due to a promotion at my local bank. This is a regional bank, and they offer a pretty good interest rate (currently more than 1%) on your checking account (up to $25K) if you meet three requirements: have your paycheck auto-deposited, pay at least one bill online, and make at least 12 debit transactions per month with thier debit card. I am guessing they can offer this rate due to the money they earn on the debit transactions (which are usually way more than 12/mo).
    This promo rate has stayed higher than the yearly CD rates, so it made sense to create a ‘buffer’ in my checking. The positives are the interest, and this account also reimburses up to three atm charges a month, and having the buffer so not having to worry about your balance all the time, as you mentioned. The negative though is that having easy access to this buffer makes it easy to spend that money. I haven’t kept real close track, but I probably have spent whatever extra interest I have earned (and maybe then some)…

  3. I really like the airplane/autopilot analogy!

    Our buffer is in time rather than in money, actually. We do track our spending to the penny and zero out our checking account on the last day of the month – sweep the extra dollars into a savings account or plump it up a bit from savings when necessary. However, our budget operates on a monthly basis (the 1st to the end of month) but we are paid on the 25th. Basically we have a 5 or 6 day grace period between when we are paid and when the next month’s expenses start coming up. If something strange happened toward the end of the month when our checking account is low, those paychecks would be there.

    Aside from the paycheck timing, the other reason I haven’t found a buffer to be necessary in our situation is that we use credit cards, not debit, for the vast majority of our purchases so we choose when to pay them off throughout the month and that we have a savings account (aside from our EF) at the same bank as our checking so we could instantly transfer money over if an unexpected charge came up.

    All that said having a buffer is a great idea to keep you from unnecessary bank charges if your life/financial situation has the potential to incur them.

  4. I have alerts sent to me when my bank accounts go below a certain threshold. Really helpful reminder to keep be within the bank account buffer zone.

  5. I actually use a separate savings account that is tied to my checking account as a free overdraft protection option. My bank allowed the tethering free of charge, so I’m not sure how universally this tactic would hold, but it serves 2 key purposes for me. First, since my checking account is my “free to spend” money after all my savings, IRA, mortgage, etc expenses (basically my NUT) I’m better at psychologically controlling that “spend it all” urge. When it’s down to the single digits, I hold off my discretionary spending until pay day. Second, if I DO dip into that O.D. Account, I get an automated email notification. If I knew it was coming because I had a huge vet bill and didn’t get to my transfer funds option in time, no big deal. But if it was an unauthorized charge (knock on wood) I will know immediately that it wasn’t me. Otherwise, it could take me a few days to realize that I should have had more money and suddenly it’s just missing. I actually had a credit card number stolen and if it weren’t for automated notification it would have been a LOT worse.

  6. I really like your analogy of the autopilot and altitude! I have never thought of it that way. I always keep a buffer in my checking account but not for overdraft reasons. Like some of the other people who commented, I also use my credit card for most of my purchases.

    Instead, I keep my buffer equal to at least one month’s income. I read some articles about the ease/comfort of living off last month’s income. So, I always pay all my bills/rent first of the month from the income earned the month before. It’s very simple once you get that money saved up. It took me close to a year to get it fully set up, but it’s worth it!

  7. I’ve kept a checking account buffer since I first opened my checking account before heading off to college about 15 years ago when I had no idea how to manage money. I’ve never heard the suggestion to keep a buffer amount tied to income, but it definitely makes sense. I like to have $300-500 buffer because it’s a range that makes me feel comfortable.

  8. As I am paid monthly I feel comfortable keeping a larger buffer. I have most credit cards autopay a few days after my paycheck (the ones I can’t adjust the due date pay earlier) and my rent at the start of the month, but I’m only paid once. I’m shooting for a buffer of an additional month’s pay, in case for some reason there is ever a delay to my direct deposit.

  9. I agree that you need a few extra dollars in your checking account over what you spend. If my account drops below $1,000, I start feeling antsy and know that’s my cue to stop spending. Thankfully, that almost never happens!

  10. I’ve been inconsistent over the years with the amount of cash buffer I find necessary. However, I’ve found that it is good to set a limit though. When you begin putting some of your finances on auto pilot, it’s easy for cash buffers to fluctuate. I’ve had times where I’ve had too much sitting around and it leaves me in a situation where I’m not using using the money as efficiently as I should. The limit helps me keep the buffer in check.

  11. Mac Hildebrand says:

    So a buffer keeps the low-flying worry to a minimum without the stressful organization of tight budgeting. This seems like a great common-sense revelation that isn’t entrenched in the mysticism of the “5 easy budgeting steps…” of so many financial advice books that you mentioned in the part 1 post. You mentioned that building a buffer is still possible and necessary even with substantial credit card debt and the accompanying payments, but I’d like to hear more here. This is where we can get discouraged the most, knowing we have those payments hanging over our heads and “low flying” seems inevitable. I like that the buffer idea still persists with credit card debt, but can it still be built up in 30 days? You might be addressing this more in part 3 and 4, but I love the practical sense here and can’t wait to hear more thoughts.

    • David Weliver says:

      Thanks for the comment, Mac.

      I should clarify that when in credit card debt, I think you should suspend extra payments to the cards until you establish a buffer as long as you are *current* on your debt payments. If you are in risk of or have already fallen behind on debt payments, the priority is always to get current.

      That said, I hadn’t planned to go into tips for saving the buffer in 30 days in parts 3 and 4 simply because that gets off my main topic a bit. But if you’re looking for some starting points here are some helpful posts both from me and others:

      How Baker paid off $15,000 in 9 months selling stuff on eBay ($15k may be extreme but I think finding stuff to sell is the fastest, easiest way to come up with a cash buffer):
      http://manvsdebt.com/sell-stuff-on-ebay/

      31 Days of Savings – More little things you can do to save money long-term, but may still be helpful:
      http://www.moneyunder30.com/31-days-of-saving

      Ramit’s save $1000 in 30 days challenge:
      http://www.iwillteachyoutoberich.com/blog/announcing-the-save-1000-in-30-days-challenge/

      • Mac Hildebrand says:

        Thank you for the helpful links, David. I especially like the tips for getting current on debt payments that emphasize cutting back on needless spending and removing clutter at the same time. Great way to top off the 31 part list with enjoying life while not spending too. Thanks for the practical help.

  12. I have been doing this since I started working at a bank when I was 17. I saw so many people overdraft themselves into oblivion, that is scared me into keeping a buffer. Now that I am out and working, I keep a $10k buffer in my checking account. Its is more than the 25-50% monthly income that you recommend, but it falls under the “what makes me comfortable” caveat. I also have a 6 month EF. I personally choose to keep a higher amount because I am an avid stock market investor and having extra cash on hand (say $5k) is great so that I can tap into when the market takes a dump and it is time to buy, and still keep my buffer. But I can attest that having a buffer has allowed me to comfortably put everything on autopilot and I am proud to say that I have never overdrafted my account…ever!

  13. Question about the buffer… Do you need one if you really don’t overdraft and/or you have overdraft protection on your account? I ask because I RARELY overdraft. Did for the first time in about 3 or 4 years a month ago, and I think I’ve only done it 3 times in my whole life. So when I just opened a new checkings/savings, I paid $10/year for protection so the money would get pulled from my savings account. This is for things like bill pays, rent, and things like that. I declined them to authorize debit card overdrafts.

    Anywho… My savings account is giving me 1.5%. I feel since I already invested the $10 overdraft protection, what would be the benefit of having a buffer instead of letting my money sit in savings to gain interest? When I figured out what buffer I would like, it would be around $500-$700, which I would hate to see not gaining interest. But I truly am open to hearing the upsides of my keeping the buffer for my situation.

    • I would say it is up to you. I will say that i have never overdraft and still have one. Really there is not one good reason to not have more money to back you up in hard times. I really think if more people lived by this rule there would not have been so many people struggling to make ends meet once they lost there jobs. I try live with as little debt as possible in mine and my wife’s life.

  14. I love this buffer Idea. I have right now $300 for the buffer. Which is about 20% of my bills a month. My goal is to get it to $500. I also have right now about 3.5 months of EF. I would say that I don’t need this buffer as I have not lived pay check to pay check in many years. I am military so my pay checks are steady. I also never go that low in my checking account. But I like this idea for incase of a emergency I can tape that $500 before i touch my EF account. It also just makes me feel that more secure in my life. It’s all most like having another lock on your door, you might not ever need it but it’s there just incase you do.

  15. I keep about 1 paycheck (paid biweekly) in a linked savings account. My bank will automatically transfer money from the savings account to the checking account if a charge goes over my balance and they do not charge a fee. I also am earning some interest (although not much) by holding the money in the savings account rather than the checking account. Even though I’m not earning much on this money, the peace of mind makes it worth it.

  16. I keep a bank account buffer which also helps towards interest, because it is a High Yield Checking Account. However, if I’m looking to open a second checking account (one account for bills, the other for miscellaneous/just-for-fun expenses) should they both be High Yield, or should only one account be High Yield or high interest?