When it comes to deciding how much cash you should keep in your checking account, the right amount depends on your financial situation. That being said, there’s a good chance that one you hit $5,000 in checking (that is, $5,000 in liquid assets), your money could be put to better use elsewhere.
Here’s why you shouldn’t keep more cash than necessary in your checking account, and what you should do be doing with your money instead.
Why you shouldn’t keep too much money in checking
For our purposes today, let’s agree that $5,000 is a lot of money. At the very least, it’s a lot of money to keep in your checking account, where it’s earning little to no interest—which is less than ideal for growing or investing your money.
The rule of thumb is to try to keep one or two months’ of living expenses in your checking account at all times. You don’t want to cut that amount too close, so if you’re prone to getting hit with overdraft fees, you might need a little additional padding.
But that means that unless your monthly expenses add up to $5,000, there are smarter places to stash your hard-earned funds. We’ve previously recommended dividing your money into multiple accounts, which helps you more easily differentiate and track your progress toward your saving goals. Beyond that, it’s time to start investing, eliminating debt, and spreading your wealth in other directions.
What to do if you have too much cash in checking
Let’s take a look at the basic accounts you need if you have a big chunk of change wasting away in your checking account.
Put some in a high-yield savings account
Once you’re in a place where you can afford to focus on savings, a high-yield savings account is a primary way to get at least some return on funds you know you’ll be accessing in the next one to five years.
Think about it like this: If you deposit $500 into a run-of-the-mill savings account, you’ve earn $0.50 in interest in one year. With a high-yield account with 2% APY, you will earn $10 on that $500—and with more time and more money, that interest adds up. Here’s our guide to choosing a high-yield savings account.
Choose a short-term certificate of deposit
A certificate of deposit (CD) is another vehicle for you to earn interest on your savings. They’re different from a traditional savings accounts because they have a temporal component—they are usually offered for terms ranging from three months to five years. Longer terms deliver higher interest rates, but you can still earn a decent return even if you don’t want to keep your money tied up for long. The downside is if you need to withdraw your money from the account before the set time period, you’ll pay a penalty.
Pad your retirement accounts
If you aren’t saving for retirement already, your two main options to get started are an IRA and a 401(k).
There are two main types of IRAs: Traditional and Roth. In the simplest terms, with Roth IRAs, you pay taxes on your savings now. With traditional IRAs, you pay taxes later, when you withdraw the money at retirement. We’ve written about the differences in more detail here, and we generally lean toward choosing a Roth account over a traditional IRA.
A 401(k) is a retirement savings account offered through your employer with significant tax benefits. If your workplace offers a 401(k), aim to contribute 10% to 20% of your paycheck. Here are our guides to opening an IRA and opening a 401(k). If you have a 401(k) account through your job, then you’re already on your way to investing. Speaking of...
Open a brokerage account
While savings accounts are the choice for money you’ll need to access in the next few years, an investment account is a vehicle to truly grow your net worth. A brokerage account is an investment account used to trade assets such as stocks, bonds, mutual funds, and exchange-traded funds. Setting up a brokerage account is simple, and can be done through an investment firm like Vanguard or Fidelity.
If the very thought of putting money in the stock market makes you nervous, I hear you. All investing involves taking a risk and being willing to ride the ups and downs of the market. But the simple fact is, your money will grow significantly more in a brokerage account than it will in a savings account. And for more passive, risk-averse investors (like yours truly), look into robo-advisors as the ultimate “set it and forget it” tool. Here’s our guide to getting your feet wet with investing.
It’s important to understand, at least at a basic level, all the options out there for you, depending on how much you can afford to set aside right now. Whether you’ve been squirreling away cash your entire life or have a bit of extra green for the first time, you don’t want to miss out on the potential for major returns by letting too much money sit in your checking account for too long.
