People form money habits over many years. Many of these habits are passed down from generation to generation as good ways to manage one’s money. Sadly some of these habits are going obsolete in the current low interest rate world. They made more sense when interest rates were high. They matter very little when interest rates are low. Some have even become counter-productive. We need to learn some new habits.
Old Habit: Pay Bills As Late As Possible
New Habit: Pay Bills As Soon As They Arrive
The cardinal rule in managing cash flow has always been "collect as soon as possible, pay as late as possible." This way you keep the money in your account longer and you earn interest on the money. This is called the float.
When you could earn 5% interest on the float, it made some sense to stretch out paying the bills. When you earn only 1% interest, to delay paying a $100 bill for 20 days will earn you only $0.05 before tax. People still cling to this habit even though the payoff simply isn’t there any more (it wasn’t much to begin with).
Unless you are letting the biller charge your credit card or debit your bank account automatically, I would suggest you pay your bills as soon as they arrive. Don’t even bother scheduling them to the due date in online bill pay. If for whatever reason you forget, set it wrong, or if the bill pay service screws up, the float isn’t worth the hassle to make the necessary phone calls to have the late fees waived.
Old Habit: Keep Checking Account Balance Low
New Habit: Leave a Large Cushion In the Checking Account
Because you typically don’t earn interest in a checking account, the old habit says you should keep the balance low in the checking account. Transfer the excess to a savings account or a money market fund; transfer back when you need it in checking again.
It was all good when the difference in interest rates between a checking account and a savings account or a money market fund was high. Nowadays it makes little difference. At my bank, Alliant Credit Union, the rate on the savings account is only 0.05% higher. Even if I keep an extra $10,000 that I don’t really need in my checking account throughout the year, I’m only out $5 before tax in lost interest for the whole year.
Transferring back and forth does nothing except mental accounting. If somehow you mis-calculated and you cause an overdraft, you will have to call again to have the overdraft fee waived. Leave a large cushion in the checking account. It’s Okay.
Old Habit: Adjust Tax Withholding
New Habit: It’s OK If You Get a Tax Refund
The old habit says you are supposed to adjust your tax withholding so as not to give Uncle Sam an interest-free loan. Well if you put the money in your bank account, you are giving the bank pretty much an interest-free loan anyway.
Behavioral economics says if you adjust your withholding and you get a higher take-home pay, you are likely to spend the extra money. That’s the thinking behind the payroll tax holiday this year and last year and the Making Work Pay tax credit before that. If you have a large tax refund, you are more likely to save at least a large portion of it if not all of it.
Giving Uncle Sam an interest-free loan is just fine. Don’t worry about it.
You get the theme. In a low interest rate world, you don’t have to run your money as tight. Relax. Is that a silver lining? What other good money habits are going obsolete in this new normal?