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It turns out you can have too much of a good thing — when it comes to the money in your checking account.
Your checking account is the hub of your financial life, so it makes sense to keep a good amount of money in it. But keeping too much money in the bank can hinder your financial growth.
By holding onto excessive cash, you’re essentially leaving your wealth stagnant, missing out on the chance to earn interest and watch your money multiply.
Why you shouldn’t keep all your money in your checking account
Checking accounts serve as a day-to-day transaction account. When you get paid, the money arrives in your checking account. When you spend money or pay bills, the money comes out of your checking account.
You likely spend money daily, so easy access to funds like this is essential. Banks will often prioritize checking account services like online bill payment, debit cards, and ATM access, rather than providing robust options for saving and growing your money for the long term.
It’s important to keep some money in your checking account. The last thing you want is to have to pay a bill or make a purchase only to find that you don’t have the funds available.
But keeping all of your money in your checking is also a bad idea.
Checking accounts are not meant for long-term savings because they offer low (or no) interest rates. If you put your money in a different account, like a high-yield savings account, you could earn some interest and grow your balance over time.
Suppose you have $10,000 that you don’t need for everyday expenses. If you keep it in a checking account with a typical interest rate of 0.01%, you would only earn $1 in interest after one year. If you transfer those funds to a high-yield savings account with a 5% interest rate, you would earn $500 in interest over the same period.
It’s also important to consider the impact of inflation on your checking account funds. If inflation is higher than the interest rate you’re earning (and for most checking accounts, it is), your money loses value over time.
For example, suppose the inflation rate is 2%, but your checking account only earns 0.01% interest. In that case, your purchasing power effectively diminishes as the cost of goods and services rises faster than the growth of your funds.
Finding the right balance
The median checking account balance is $2,900, according to a recent Federal Reserve study. The right amount to keep in account will vary based on your spending habits and needs. You should have enough in your checking account to handle a few months of expenses.
“Your checking account should hold about two months’ worth of your typical living expenses,” says Riley Adams, certified public accountant. “This should be more than enough money to account for pre-authorization holds and other general money fluctuations and keep you from overdrafting.”
The right number will depend on your spending habits and risk tolerance. Someone who spends $5,000 monthly will want more in their checking account than someone whose monthly budget is half that size.
Review your monthly expenses, including bills, rent payments, groceries, and other necessities. This will give you an idea of the minimum amount you need to keep in your checking account to cover these expenses.
Also, look at your income sources and how often you get paid. This will help ensure you have enough funds in your checking account to cover any upcoming bills or payments.
Where to put the extra funds from your checking account
Once you’ve decided on your target checking account balance, you can choose where to put your extra money.
“You might want to save for retirement, in which case I’d say to sock it away in tax-advantaged retirement accounts, like IRAs and Roth IRAs,” says Adams. “If you have other long-term financial goals where you’ll need to spend the money before retirement, consider growing that money in a taxable brokerage account.”
Other options include:
- High-yield savings accounts offer a higher interest rate than a traditional checking account. It provides a safe and accessible place to store extra cash while earning interest.
- Money market accounts offer competitive interest rates similar to a high-yield savings account. They may come with features such as check-writing abilities and ATM access while providing easy access to your funds.
- Certificates of deposit (CDs) have higher interest rates than regular savings accounts but require you to lock in your money for a specific term, such as six months or a few years. They are a good choice if you don’t need immediate access to the funds and want a fixed rate of return.
You don’t want to keep too much money in any single type of account. Diversifying is important.
If you have a huge amount in savings, for example, you’re missing out on the higher potential returns and the tax benefits of a retirement account. Putting too much into a retirement account locks your money up until you reach a certain age, so it’s smart to have some funds in a more accessible place.
Managing your checking account more effectively
Properly managing your checking account means knowing how much you make and spend each month.
Building a budget is one of those things that isn’t fun, but is essential to handling your finances. Spend a month or two tracking your spending, either yourself or by using an app, and then use that information to build a preliminary plan.
Consider setting up automated transfers to a savings account. Making the process automatic makes it harder for you to overspend and is a good way to build up an emergency fund.
If your checking balance is getting too low, look at your recent expenses to see if you’re overspending or had an unexpected expense. Try to reduce your spending until the balance rises. If your checking account has more money than usual, you can move the excess to your savings.
The bottom line
Your checking account is often your main financial account, but it shouldn’t store all your money. Consider your spending and risk tolerance, then create a target amount of cash to keep in your checking account. Then, you can use the excess money to focus on goals like saving for the future or building an emergency fund.
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