How much money should keep on hand in the bank? And what if that money doesn’t earn very much while it’s there?
One of the first recommendations I often make to new clients is that they stuff some money in a boring old bank account, ignore the interest rate the bank is paying and see even a 0% paying account… for the wonderful wealth building opportunity it can be.
How much should you have? I often hear three months’ worth of your spending.
Having three months’ worth of living expenses in a bank account is much better than having nothing. But I’d love to see your account equal six months of your annual income. I’ll tell you why in moment.
This is going to take a serious commitment on your part. If you were starting from scratch and saving 10% per year, it would take you five years. If you save 15% (my typical recommendation), you’ll reach this goal in about three years.
And, yes, I want you to keep all that money in a boring, low interest rate, guaranteed, predictable and available bank account. The important thing here isn’t the interest rate earned, but the availability of the funds in the event of an emergency or opportunity.
I call this your emergency and opportunity account, or “E&O account” for short. And I want you to treat your E&O account like a bank…a bank you own.
The E&O account is simply a traditional bank account from which you can “borrow” to spend on big ticket items you would normally have to finance with debt. This may include automobiles, major appliances, vacations, etc.
You are not actually borrowing anything – you are withdrawing your own money. Yet you want to treat the withdrawal as a loan, and pay it back…with interest. You can use an online calculator to figure the payment due each month over an appropriate period of time. Set up a repayment schedule, just like you would if you had a car note or a loan repayment to a bank.
This strategy of “borrowing” from and repaying yourself is the perfect way to keep your spending and capital replenishment in balance.
The key with the E&O account is the use the same cash flow you would normally send to a financial institution in debt repayments to simply replenish your own capital after you spend it.
If you cheat yourself on this point, you’ll be the one to pay the price.
Don’t overlook this simple, low risk strategy to build your wealth slowly over time.