Putting your money to work for you is a common financial goal. We get it—you work hard for your money so it’s only fair that your money works hard for you too! But optimizing your finances doesn’t always mean shooting for the highest return on every dollar. In fact, that’s a good way to destabilize your finances because a higher potential reward also means higher risk. Instead, think about what level of return is reasonable for the purpose of your money.
Define your buckets
We like to think about your money as individual buckets: you have one bucket for bills, one bucket for spending, one bucket for emergencies, one bucket for travel, one for car maintenance, one for a home downpayment, one for retirement…Your exact buckets will depend on your goals. Splitting up your money into buckets by separating it into different accounts helps you identify the purpose of every dollar. Without that separation, your money can feel like an amorphous blob and you can fall into the trap of having unrealistic expectations of the return you should get on it.
Optimize your buckets
Once you’ve defined your buckets, you can optimize each one according to its purpose.
Best Place to Keep Your Spending Money: Checking Account
Money intended for spending on your bills and daily living expenses is best off in a checking account. These funds should be optimized for access and functionality, not returns. High yield checking accounts exist but they often come with direct deposit and minimum transaction requirements. It might be more important to you that your bank doesn’t charge overdraft fees, has a great bill pay feature, or useful budgeting tools. Since your checking account is just a temporary holding place for your money, it’s generally unnecessary to keep more than a month of expenses there.
Best Place to Keep a Buffer: Regular Savings Account
If you don’t keep more money than you need in your checking account, it’s helpful to have some additional cash close on hand in case something like your utility bill is higher than expected or you have a co-pay for a doctor’s visit. You want to be able to access this money immediately so a savings account at your primary bank is best for this. You don’t need to keep more than a few hundred dollars (or up to one month’s of expenses) here. Keep in mind that savings accounts at most brick-and-mortar banks offer very low interest rates—they are basically glorified checking accounts, but giving up some return for speedy access makes sense.
Best Place to Keep Your Emergency Fund: High Yield Savings Account (HYSA)
A high yield savings account is best for money that you can wait at least a few days to access. This includes your emergency fund. While the word “emergency” implies urgency, typically you have enough notice to access the money for something like a medical bill, job loss, or even a car repair. Because this is money you don’t have to tap often, it’s worth getting the higher return of a high yield savings account.
Best Place to Keep Money for Near-Term Goals: HYSA or Certificate of Deposit (CD)
A high yield savings account is also an appropriate place to keep money for any goals you’re saving for in the next three years. While it’s possible that you could grow your money more by investing it, it’s just as likely you could end up with less. You don’t want to have to worry about whether you’ll actually be able to pay for that vacation you have planned or buy that car you need based on how the stock market is doing. A certificate of deposit (CD) is another safe place to keep money for near-term goals and still earn a decent return. However, CDs aren’t as flexible as HYSAs and usually offer rates that are only slightly higher than a HYSA. For this reason, a CD is a better option for cash that you already have set aside for a particular goal.
Best Place to Keep Money for 3+ Year Goals: Investment Account
For goals that are three or more years away, you do want to optimize more for returns by investing your money. But even here, the goal is not to shoot for the highest possible returns because that also comes with the highest risk. Instead, for a high likelihood of a return that will outpace inflation and then some, it’s best to invest in index funds that are trying to match the stock market, rather than try to pick the winners.
