Maintain Minimum Balance in your Savings & Checking Accounts

The prime reason for us to have a balance in Current and Savings accounts to help with liquidity and easy access to money when we need it. Usually Savings and Current accounts do not give a good interest on our deposits. Hence we have a dilemma, our balance shouldn’t be so low that we wouldn’t be able to cover our expenses or emergency requirements that may arise and they shouldn’t be too high as the money will lay idle and not grow. The best way to solve this problem is two pronged. Firstly, we need to have an increased awareness of our income and outgo each month and predicting cash requirements for subsequent months. Once we solve this piece of puzzle, we need to align our expenses to income and smoothen out the cash flow.

The other benefits of just the right amount of money in our savings and current account are:

• Money needs to work for us and make more money and not stay idle. Extra money that we would save after this exercise can be deployed in investments that give us better returns and we can structure them in such a way that they would be easily accessible in a matter of days if an urgent need arises.
• Our temptation for discretionary spending reduces as our bank balance looks low (but the money is invested at the right places). This will bring a certain level of discipline in our spending habits.

How to Implement

Determine a Comfortable Buffer

First step to this exercise is to decide how much buffer we need in our account. There are thumb rules that we can use to guide us. We need to look at all our expenses in the past 12 months and observe their trends.

We need to have a ballpark categorization of discretionary and mandatory expenses. Discretionary expenses can be avoided when we have a financial emergency or when our income suddenly stops. Few examples are dining in restaurants, leisure travel, home improvements and entertainment. Mandatory expenses on the other hand would have to be incurred no matter what. Few examples are utility payments, grocery, medicines, child care expenses, mobile and internet.

Then we need to assume what will happen when the income stops (for whatever reason). As a thumb rule, we would need to cover 3 months of mandatory expenses plus an emergency fund for unexpected expenses that may arise. The latter is very subjective and depends on your risk taking ability.

This money needs to be liquid and available for us to access in case of a financial emergency. Note that this amount need not be kept in your savings or current accounts. It will have to be invested in assets that can provide us access to money within days when needed.

Be aware of the minimum balances that you would need to maintain in your savings and current accounts to avoid bank charges. For most current accounts, the minimum balance of $0 can be maintained. Few accounts require a $500 average monthly balance if the account is setup for monthly direct deposits and $5,000 average monthly balance if the account does not have any monthly direct deposits. Note the words average monthly balance. This means that for 20 days in a month (usually coincides with the statement period), you can have $1000 in your accounts that are receiving direct deposits and for the remaining days, you can keep a $0 balance and still be higher than the requirement of $500 average in a month.

Understand your income and expenses

Once you have made the determination and set your limits, you need to start putting down actual expenses in a spreadsheet. More the historic data you have the better as it can help you closely analyze trends and how your spending changed as a response to any emergency events in the past. This can provide you with good insights. Also, you may need to do the exercise for your rolling credit account if most of your spending would be done through them.

Next, categorize each expenses type as utilities, shopping, gas, entertainment, child care expenses, groceries, travel, dining, etc. You can now easily categorize the expenses in two main buckets – discretionary and mandatory.

Analyze these expenses and come up with their trending over the past 12 months (if more data is available then understand if the expense is trending upwards or downwards. Use this trend to forecast these expenses for the next 3 months. Factor in seasonal variations in spending like electricity bills would tend to be higher in summers and gas bills would be higher in winters. Another good example is credit card payments would be higher about a month to 45 days after holiday seasons.

It’s just a feel good factor to see a larger savings and current account balance. Intuitively, we would have all payments made on the first of every month. Below example illustrates how this would not be a good strategy.

It’s better to align the major expenses soon after you receive the income so the minimum contingency amount balance is what remains throughout the month. Also, you are in better control of your outgo and don’t have any surprises in store when you look at your account on the 1^st of the month. Look at the big expenses – it may typically be a mortgage payment, 2-3 rolling credit payments. Space them out almost evenly across the month.

You can change payment dates for most rolling credits simply by calling them. For mortgage payments, you can pay the same in the first 10 days of each month without incurring a penalty. Line up the dates accordingly.

If required, observe the spending trend for a couple of months and make adjustments if required. If you have a HELOC account setup, line up the automated transfer from your bank account to HELOC account when you receive your income and transfer back when you need to make a payment and the bank account doesn’t have the required funds.