How Much Money Should You Keep in Your Checking Account?

When I first started working and earning my own salary, it felt good to see money coming into my bank account every month. My expenses were reasonable, so six months later, when I saw a good amount of money sitting idle in my checking account, realization dawned that my money could be put to better use. But I faced a dilemma: How much in my checking account was enough?

The trick, I understood after a lot of research was to meet expenses but not leave too much in unproductive assets. So here's what I did:

Step 1: I kept one month's expenses in checking account
A checking account was the primary account through which I made all my expenses. All my instructions for automatic bill payments and loan installments happened through this account. So in case, for some reason, my salary for the next month was delayed, the balance would help tide over those expenses. So this account needed to have at least a month's equivalent of expenses as balance. Keeping any more than that was of no use because the money in the checking account didn't earn any interest.

The challenge was to calculate one month's expenses. I took a total of all the debits in my bank account for the last six months. I excluded large one-time expenses and arrived at an average for one month. I also added certain expenses that I was certain would come up in the next few months. This would give me the best ballpark for a month's equivalent of expenses.

Step 2: I parked 3 months' expenses in savings account and liquid funds
This was like an emergency fund. Suppose I lost my job or had to discontinue because of ill health, this fund would help me tide past the temporary setback. I thought 3 months was sufficient for me, but you could choose to park a little more depending on your individual profile, going even up to 6 months.

Naturally, an important feature of this fund was that it had to be liquid, that is, encashable at short notice. But since I would not draw on this fund as routinely as a checking account I could park the money in an account with a certain lock-in, thus, enabling me to earn some interest.

The best options for this were a savings account, a short-term CD or a liquid mutual fund such as a money market fund or income fund. All these would give you an approximate interest rate of 1-1.5% per annum.

Having taken care of my routine expenses and emergency financial needs, the rest of the money was available for investing. Where I would invest would depend on my financial goals. For instance, for goals longer than 5 or 7 years, I would invest in aggressive instruments like equities.

This exercise was useful to me in a number of ways. Firstly, it helped put my money to better use. Secondly, it helped me get a grip on my expenses. After completing step 1 and 2, I knew how much I had left to invest and whether that was enough for my financial goals. If it wasn't enough, I knew I had to go back and revisit my expenses. While I couldn't cut back on certain important expenses like insurance, there were some expenses I could try and control.

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