This is the second part of a series on setting up a financial plan.
The beginning of the series is here.
The next article is “5 Accounts, #2 – Online Savings“.

Just about everyone has a checking account, and a lot of people (my former self included) misuse it horribly. In the UK, such accounts are generally known as “Current Accounts”, which is actually a far more useful way of thinking about them.

The upside of a checking account is extremely easy access – through cheques, ATM withdrawals or debit-card purchases, you have a ready flow of money available at all time.

Every dollar you keep in that account, though, is losing value over time. This is because the measly interest rate on checking accounts doesn’t match inflation, which generally runs at 3-4% per year. So $100 kept in a checking account for a year will only be worth the equivalent of $96-$97 in “today’s money” a year from now.

Your checking account should be your primary “monetary interface” with the rest of the world – it’s usually where your paycheck goes, and the account that you’ll use to pay for rent/mortgage payments, groceries, meals out and all the other day-to-day transactions involved in just living. You should constantly pare it down, though.

I want my current account to contain a “buffer” to cover any small unforseen expenses (inpromptu nights out with out-of-town visitors, new socks because the old ones all have holes, a higher heating bill due to a cold snap, etc), plus the amount necessary to pay the upcoming costs I know are due in my budget.

The buffer should be enough that I’m not risking overdrawing – overdrawing on an American bank account is an extremely expensive proposition that can quickly rack up a painful debt. The rule of thumb I’m following is to keep an amount equivalent to an average week’s spending, over and above what I know I’ll be spending between now and next paycheck.

Working out your “average weekly spending” is pretty easy (and you can round up if you want extra security). Just take your previous month’s bank statement, cut out all of the “big ticket” items (rent, loan payments, predictable bills), tally up the rest of your spending and divide by 4.

As each paycheck arrives, I work out the “big ticket” items that are upcoming, and add three times my “weekly spend” – the amount I’ll need to live till next paycheck, plus my “buffer”.

Anything over that amount is “swept” into my Online Savings account. We’ll cover what happens to it there in the next installment…

One final point – I’m still early into this, so I check my spending and balance every day or two via online banking so that I can detect any “overspends” early, and either budget more aggressively (the preferred option), or transfer money back from Online Savings to “cover” myself.

An example

So, say it’s payday. Your checking account currently contains $700, your bi-weekly paycheck comes to $1700, your rent ($850) is due, and you spend about $300 per week on food, entertainment, small bills etc. If you were following my plan, you would budget $900 (two weeks’ spending plus “buffer”), plus your $850 rent, for a total of $1750. This leaves $650 of “unnecessary money” in your checking account, which you should transfer to somewhere more productive.

Disclaimer: I’m not a financial advisor, and I’m just sharing my own financial plans because, well, I like to share. It’s also a good exercise in “thinking out loud”. You choose to follow any advice in these posts at your own risk, though – I’m not responsible if you overdraw or suffer other financial calamity…

The WaMu advert photo on this post is from ThinkingCouch on Flickr.

This article first arrived on the interwebnet on Wednesday, August 15th, 2007 at 9:28 pm .
It's arbitrarily categorised as being about: Finance, Financial Planning, Thinking.
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You know, this article used to be 4000 words longer, but right before I pressed 'Save', the dog ate it. Honest.