…And save yourself mental clutter

 

writing check

Most people I know hold a single bank account or at the most 2 accounts – out of which 1 is a salary account. This account is used for all financial transactions in life -

  • Regular expenses like groceries, electricity, phone etc
  • Irregular expenses that do not occur every month but at specified times in a year like insurance, car service etc
  • Miscellaneous expenses for items such as eating out, movie tickets (or indirectly to credit cards)

Image source: Vangelis Thomaidis

Why having a single bank account is bad for you?

A single inflow and outflow box for your financial transactions does not make sense. Here’s why.

Difficult to set a budget and track against it

    If you make a rough budget, you apportion it to major categories such as groceries, electricity etc. However, your transactions don’t happen in a nice, single purchase. Most often, they are distributed over the month, making it difficult to track against the budget, especially if you do not track at a granular level.
    Also, if you are like me, you withdraw cash at ATMs for payment towards many of the expenses. This appears in your bank statement as withdrawals, making it difficult to allocate it to the appropriate category.

Limit impulse purchases

I have not yet reached the stage of setting limits for entertainment/eating out/impulse purchases (music, food, movies), since I can’t seem to reliably predict those expenses. You may have budgeted for it. In both these cases, it is easy to go overboard and spend more (since you have the money now).

Security issues

With almost every service provider offering the option to pay bills online, it is fast becoming the method of choice for bill payment as well as purchases. However, using the same account for online transactions may increase your exposure to security issues. With ATM/Debit cards, there is limited liability even when you complain, as the money removed from your account cannot be recovered.

Funds not available for irregular expenses

When the bills for car insurance renewal, annual premium payments or other expenses that do not occur monthly come up, you may find yourself with a shortfall in funds. You then have to dip into debt sources to fund these payments.

Low interest rates

Your savings account, even if you have a lot of spare cash in it, will earn you a measly 3.5% interest rate. Income Tax returns, sale proceeds and other spare cash tends to lie in such accounts waiting to be spent (and does vanish into GOK accounts!)

Solution: Create separate accounts

Regular Bills

Setup specific accounts for regular and irregular payments. With most banks allowing online payment, regular bills and operating expenses such as fuel, vegetables etc can be bought using the regular account. This regular account can be the pay-linked account provided by your company.

Irregular Bills

Total all irregular income for the year (planned) and divide by 12, to get the amount for each month. Set up separate account for the irregular expenses and pay from that account.

Target accounts

If you have other financial goals and you have budgeted for it, either keep a separate account or use the irregular expense account.

For investments such as payments to mutual funds, use a separate account for inflow and outflows. This also makes it easier to find out your tax liability for short-tem capital gains and pay accordingly. [It also makes it easier to get a TDS certificate for such gains]

Note: In India, ICICI Bank, for example, allows you to link your accounts, so that you can transfer money between your investment account and savings account easily.

The Smart Account

For irregular and any target accounts, choose a smart money account  where after a defined threshold is reached, any extra money is put into a separate high-yield account (with Fixed-Deposit rates). This account has full liquidity and you can take everything out if you need.

Note: In India – ICICI, HSBC, Citibank, HDFC Bank are among the many banks that offer this type of account.

Diversify

Ok, this is a word of caution I added after the recent chaos in the banking industry. Like any portfolio, it would be wise to spread your accounts across banks.

Choose your Account type carefully

All banks generally offer different types of accounts with different facilities, minimum account balance (MAB) and charges. Choose very carefully among these accounts to avoid unnecessary charges since you may not need to use all the features of a full-fledged account. For example, many banks offer a no-frills account with zero MAB, a basic ATM card and access to online banking for little or no annual charges. Choosing different banks allows you to avoid putting all eggs in one basket

Having separate accounts allows you to plan efficiently and avoid the mental clutter when dealing with different expenses that arise at different times.

Share with us your strategies for keeping track of different expense categories, specifically variable and irregular expenses. While you are it, please take a moment to participate in the poll below.

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How many bank accounts do you hold?

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