Managing cash in the bank is an often overlooked opportunity in financial planning. We regularly speak to clients about how much cash they keep on hand and how to optimize their cash management system because of its critical role in efficient wealth creation and retention After income, it is one the strongest predictors of plan success for clients underway.
What shape your system takes is a matter of personal preference. There are many functional ways to structure your personal banking. For many, income is automatically deposited via direct deposit. We recommend setting up automatic monthly transfers to various goal-driven savings vehicles. The magnitude of the transfers is often determined through our financial planning process and the identification of individual goals. Automating savings and avoiding consumer debt is a proven system for meeting savings and budget goals.
Once your system is up and running, the work becomes monitoring the level of cash in your accounts. As a starting point, we recommend a ‘floor’ in your checking account of 1.25-2 months of living expenses. This floor helps to absorb larger than normal months of spending (i.e., birthdays and holidays). After you select a floor, the next step is to select a ceiling. A ceiling is typically no greater than three months of living expenses, but, in the effort to limit cash drag, the goal is keep one’s ceiling as close to their floor as possible. For people with very stable income and expenses, their floor and ceiling may be the same. If your cash falls below the floor, this can be a sign of excess spending. If your cash rises above the ceiling, this should trigger savings behavior.