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.

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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• What do you like most about it?
• What do you hate about it?
• Why did you choose it in the first place?
• Finally, what would another bank or credit union have to do to get you to switch?

This week, I was checking out a Filene Research Institute study by industry expert Ron Rubin that explained what financial institutions can do to win the business of the under-30 set. By 2020, our generation will represent of 40% of our country’s workers, and banks need our earnings to survive. The report shows, for example, that we manage our money and choose our financial institutions differently than previous generations.

We’re more likely to bank online. 22% of consumers under 30 use an online bank as our primary banking institution.

We either foolishly loyal…or just lazy. Although painful fees and uncompetitive interest rates turn us off, these factors are unlikely by themselves to get us to switch.

Word of mouth really matters. “Online banks enjoy the highest rate of recommendations compared with other types of institutions. Not surprisingly, more than half of the under-30 set indicate that the reputation of their online bank was a key motivator in opening the account, and over 40% say a recommendation from a friend or family member played a role in their decision.”

Rubin goes on to make recommendations to banks and credit unions looking to win younger customers. He suggests, for example, that banks take $1 million or so they would use to build a new branch and instead invest in their website and online services like remove deposit capture.

I think he’s on the right track. If a bank wants to win my business, I’d tell them to:

• Make your Website beautiful and simple to use.
• Make your Website do absolutely everything short of dispense cash: Deposit checks, apply for accounts, log and resolve errors, etc.
• Pay me an interest rate that isn’t a slap in the face.

Some online banks like ING and FNBO are on the right track. Of course what I’d really love is if a neighborhood credit union could offer the same. But I want to know what you think—what do you want to see in a bank that could convince you to switch?

• Are all of your hard-earned dollars earning interest?

Savvy investors know that every dollar deposited at a bank, brokerage, or financial institution should be making money… and that includes your short-term savings, cash investment balances, even your checking account. If not, you should be looking for somewhere else to store your dollars…

There are a number of financial institutions that are showing their customers love by rewarding them with good returns on their short-term savings. So where is the best place for short-term savings? Let’s take a look:

High Yield Savings Accounts

Online savings banks still offer the best place for short-term savings. I went searching for the best interest rate that you can get right now on a high yield savings account. I avoided banks with teaser rates that change after a month or two. It was important to find a reputable bank that has a history of high returns.

There were actually two winners in this category. The best savings accounts for your money can currently be found at American Express Bank and Capital One Bank. There’s no minimum to open an American Express savings account. Capital One Bank requires a $1,000 minimum to open an account.

View a complete list of top high yield savings accounts.

Interest-Bearing Checking Accounts

Your checking account should be paying you interest on your money. That may sound surprising, but it shouldn’t be. Banks should pay you for the privilege of holding your money. Most commercial banks either don’t pay interest on checking accounts or require huge minimums to pay a low interest rate. If you want to earn interest on your checking account, you should take a look at online banks.

FNBO Direct is paying account holders a 0.70% APR on new bill-pay accounts. This interest rate is higher than the rate that commercial banks are currently paying on savings accounts. The minimum balance to open a new account is just one dollar. Open an FNBO bill-pay account now.

Certificates of Deposit

Savers that are looking for the best return on their money on a long-term basis should take a look at a certificate of deposit. CD’s have terms that typically run from a period of 3 months to 5 years. Rates will increase as the CD term gets longer.

You can get the best rate on a CD at Bank of Internet USA. The bank is paying 1.48% on a one-year CD. The minimum deposit is $1,000 and interest is compounded daily. This is far better than the national average of 0.53%.APR. Patient investors can get a higher rate on a longer term CD. First Internet Bank of Indiana is paying 2.65% interest annually on a 5 year CD. This beats the national average of 1.57%.

View a complete list of the best CD rates.

Online Stock Brokers

If you are looking for the best low-cost brokers, you should take a look at TradeKing and Zecco. These online brokerages charge under $5 per trade. TradeKing charges $4.95 for every buy and sell transaction. Zecco is even lower at just $4.50 per trade. This is incredibly cheap for an online broker.

If you are seeking more investment options, you should check out Scottrade and E*Trade might fit the bill. Scottrade is just $7 per trade and E*Trade is just $9.99. The prices may be higher but it’s worth it for all of the trading tools and research that they provide.

Now that you are aware of the best rates available, you can negotiate a better deal for your money. Be sure to look for the maximum rate that you can earn on guaranteed investments like savings accounts, checking accounts, and CD’s. Remember that every extra dollar that you earn in interest is one less dollar that you have to work for.

Do you know of any other investments that are paying investors a decent rate on short-term cash savings?

Do you want your allowance in paper or plastic?

American Express just released the Pass Card, a prepaid reloadable debit card for teens that aims to simplify how you and your parents manage money…without the need for your own checking account or credit card.

For Teens

Parents fund the card by check or electronic transfer and cardmembers can spend the money loaded on the card. Because Pass is prepaid, you can’t spend more than you have. That saves you from throwing away money on interest or overdraft fees like you could with credit or other debit cards.

Plus, the Pass Card is a stylish way to pay anywhere American Express is accepted: you can choose from four colors and customize your card with an image of your choice. (It’s also earth-friendly; the Pass card is made from recycled plastic).

For Parents

Of course, Amex is hoping that the Pass Card will make parents happy, too. According to an American Express survey, 55% of parents give their teens an allowance…an average of $66 a month.

With the Pass Card, both cardmembers and parents can track spending online, in real-time, 24/7. Parents can activate and deactivate ATM withdrawals as needed. If lost, a Pass card is fully replaceable. And, the Pass Card comes with 90-day purchase protection and roadside assistance. That’s nice peace-of-mind for cardmembers and parents alike.

But Is It Worth It?

Reloadable debit cards aren’t new, but they’re gaining traction as the world moves away from cash. The American Express Pass Card and similar products work like regular debit cards (but without the bank account): you can deposit funds, make purchases, or withdraw cash at an ATM.

The biggest downside to reloadable debit cards is, usually, fees. Some charge a buck here or there for nearly everything. The American Express Pass card is better, but still pricey. The Pass Card costs $3.95 per month (although this fee is waived until October 1, 2010). Pass also charges $1.50 per ATM withdrawal.

Compare that to a free checking account that comes with a debit card, and the Pass Card doesn’t seem like a deal. But, if you have overdraft protection on that checking account and overdraw your account just once, your bank could slap you with a $35 fee. Suddenly the Pass card doesn’t look so bad.

Whether you choose the American Express Pass card, a bank account, or even a credit card, what’s important is that you don’t just spend money, you manage it. That means deciding ahead of time what you want from your money and making a plan to spend and/or save it.

What do you think? Do you/did you get an allowance? Would a prepaid, reloadable card be/have been useful?

PerkStreet^SM† announced last week it will now offer 2% cash back on all non-pin transactions for cardholders who maintain a $5,000 balance.

Everybody earns 1% cash back with no minimum balance.

Users can also earn 5% cash back at select merchants and in rotating categories (this summer it’s ice cream, home improvement, and gas).

PerkStreet has partnered with the Bancorp Bank to provide many of its banking services, including FDIC insurance. Users can simply deposit money electronically or mail checks in—or send checks overnight, for free. PerkStreet also has a nationwide network of fee-free ATMs and provides free checks. It takes a minimum deposit of $25 to open an account.

“If you’ve been spending on credit cards just to get rewards, this is the alternative you’ve been looking for. Imagine, finally being rewarded for spending wisely,” says PerkStreet Financial CEO Dan O’Malley.

In my opinion, offering 2% cash back on everything is pretty bold, because it beats many credit card rewards programs. Even the best credit card rewards only pay more than 1% cash back on certain categories or when you reach certain spending levels. And many charge an annual fee.

At the same time, this benefit blows away interest-bearing checking accounts.

With a PerkStreet card an a $5,000 balance (so you earn 2% back), if you spend $1,000 a month, you’ll earn $240 cash back in a year. $1,500 a month equals $360 a year. $2,000 a month gets you a cash reward of $480.

How can they afford this?

Well, that’s the power of interchange fees, those small percentages of each transactions that merchants (and, in turn, we the consumer) pay each time we buy something with plastic. In rewards debit cards and credit cards are just paying us back money we paid them in the form of these interchange fees.

But that’s the game, and cash back cards like the PerkStreet debit card are a way to win it.

One note of caution about debit cards: Unlike credit cards, if your debit card is stolen, the thief is taking money right out of your bank account, and the bank may take days or weeks to return it to you. Also, credit cards help you build credit; debit cards do not. (Kind of important if you’re starting out and want a mortgage someday). Credit cards can also help you resolve disputes with merchants…and you don’t pay until the problem’s resolved.

If you’re worried about going into debt with a credit card, however, that’s more than enough reason to stick with debit cards. And if you can earn 1-2% cash back while debiting…why the heck not?

Learn more about PerkStreet or open an account now.

The PerkStreet Financial Visa® Debit Card is issued by The Bancorp Bank pursuant to a license from Visa U.S.A. Inc. This site may have a financial relationship with PerkStreet Financial. For more information, read our disclosures.

It’s called BankSimple.

Cofounded by one of the original engineers at Twitter, BankSimple promises simple online services and “one simple card” that will provide checking, savings, rewards, and a line of credit. They also promise no hidden fees, including no overdraft fees.

Having one bank account—better yet, one card—that provides everything you need in the simplest way possible makes me giddy. Nevertheless, I have questions:

• What’s the Catch? BankSimple will make money somehow…so I suspend judgment until I know how. (They’re launching later this year).
• Can I Keep My Money Local? When possible, I’d rather keep my money local. That means community banks and credit unions. And since BankSimple doesn’t sound like it’s an actual bank (their site says deposits will be swept to other FDIC-insured bank accounts), I’d love to someday see BankSimple offer its products through local financial institutions. (BankSimple, if you want to use my idea, just give me a job someday!)
• What If I Lose My Card? Finally, having only one card raises the question…what happens if it’s stolen? No liability for fraudulent charges is a must, but so is rapid replacement. The thing about having multiple debit and credit cards is you can leave one locked up at home in case you lose your wallet. At least you have a way to buy things for a few days until your new cards arrive.

So I’m excited, but perhaps a bit skeptical about BankSimple. As The Financial Brand, a bank marketing blog recently wrote: Making banking simple isn’t that simple.

But what do you think? Do you like the sound of a totally simple bank that gives you the benefits of savings, checking, and a credit card in just one product? Check out their Website and let me know what you think!

Choosing the Right Overseas Bank for You

In most countries., as in the U.S., there are a lot of banks to choose from. (If you happen to be in the U.K., HSBC and Barclays are two I would recommend. The Bank of Scotland is another, a recent acquisition of the Lloyds TSB group.)

Be sure to look into fees that banks charge for withdrawals, especially within the European Union. (Most European banks won’t charge to withdraw money anywhere in the E.U., some will.) Some, like HSBC, have locations worldwide, which can be reassuring if you’re on the move. In that case, an online banking system is also a must. Fortunately, many European banks are ahead of U.S. banks when it comes to online and mobile banking.

If you can, visit a few different banks before choosing a bank that has the right features for you.

What You Need to Open an Overseas Bank Account

At the very least, you’ll need:

• Your passport
• Proof of your U.S. address

Remember, your passport does not have your American address on it, so be sure to bring something that does. A driver’s license is usually fine, as long as the name on the driver’s license is the same as the name on your passport.

To be on the safe side, also bring:

• Any government-issued work permits, ID numbers, or insurance you have acquired in the foreign country.
• Proof of your new address (a utility bill or lease agreement will suffice).

Finally, you should also let the financial controller of your company know what you are up to so he or she can vouch for you if the bank wants to call them.

International Money Transfers

Can I send your from the U.S. to my new overseas account?

Sure. Just watch out for the fees!

It costs money to send money, so if you need to transfer money on a regular basis, try to make as few transactions as possible. (That said; remember that if you transfer more than $10,000USD, your bank will declare your transaction to the IRS).

There are a few numbers you will need to transfer money internationally that you won’t know off the top of your head, so make sure you prepare in advance. All banks have a SWIFT code and an IBAN number. The SWIFT (also known as BIC) code is essentially the address of a particular bank, and is usually made up of capital letters. Check with your local bank branch for this information as all locations have their own unique code.

IBAN stands for International Bank Account Number, and is your unique routing number for your account no matter where you are in the world. Although most US banks do not format account numbers in a typical European IBAN style, you do have an IBAN and it does work! Check with your local branch before you go to make sure you have the correct information on hand.

Check back next week for more posts about banking abroad, including how to open an international credit card and how to establish credit in the U.K.