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?
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How do you think this impacts things like mortgage pre-payment? While you’re only earning a pittance on your cash reserves, you also only paying a (slightly larger) pittance in terms of mortgage interest. So do you think the current environment encourages pre-payment, or does it cause people to hand onto their mortgages for as long as possible?
P.S. We do keep more money in checking than we used to, though I think that has more to do with having more money to work with now vs. then, and also having less time to keep track of things and avoid overdrafts, etc.
I think the low rate environment makes people less inclined to prepay their mortgages, although the difference between the rate they earn and the rate they pay isn’t necessarily smaller now. I remember the mortgage rate was 6% when money market funds paid 5%. Now it’s 3% mortgage rate versus 1% in “high yield” savings account. The gap is actually larger now. I think people pay more attention to the rate they pay, not the difference between what they pay and what they earn. The common belief says the mortgage rate is cheap, it’s less than inflation after tax deduction, etc. True but if only you can reliably earn more than inflation after taxes. You can’t these days.
Harry @ PF Pro says
For a while, I was keeping my checking account low and had most of my money in savings, but it just got to be too much of a hassle, especially when I was hit with a fee for not having enough in my checking, because I forgot that an autopay was coming.
I actually recommend that you over withhold, it’s the best way to save IMO as long as you don’t spend the refund when you get it 🙂
My rewards checking account through my local credit union currently pays 3.00% APR on balances up to $25K. So the “old habits” still apply to me. I do have to meet the requirements for reward checking every month, but I haven’t yet failed to meet the requirements in over three years with this checking account.
When I notice that my balance is significantly over $25K, I transfer some to my Ally savings account.
So far, this system is working for me.
Agreed on #1 – I used to keep $200 in my checking account for when I wanted to get cash out of an ATM and then pay the credit card bill a few days before the due date. Now, I pay every single bill as soon as I get it so that I can’t forget about the bill.
Like Alskar, I have a rewards checking account, so I keep far more than $200 in my checking account these days. I have some mental accounting for keeping track of how much is savings and how much is really checking in the account.
I actually adjust my tax withholding because otherwise, I might still owe taxes come April and I hear the government doesn’t appreciate it that much if you underpay significantly 😉
Investor Junkie says
@TFB while it’s true the gap is wider with savings rate vs mortgage rate now, they are both lower than the average rate of inflation. Since debt is worth less over time in such a situation I certainly do not prepay my mortgage and is the very last item in my list to do.
There are still things I can do that either directly or indirectly earn a higher rate of return. ie. Lending Club, dividend stocks, MLPs munis, buying a rental property, buying a business, and doing improvements to the house. Only after these targets for savings pre-tax and after tax are complete for our family only then would I consider prepaying our mortgage. Only then it would be our rental unit first.
Investor Junkie: Since it’s the very last item on your list, does that mean you’d do it if you had all your other obligations taken care of? Or is it really not even on your list? That is, if you had extra cash laying around, would you invest it vs. putting it toward your mortgage?
TFB, this article is right on. I’m helping a relative with bill paying and old habits are hard to change, especially as they were successful in the past. I think the relative is finally realizing that it is much less stressful to pay bills as they are received instead of waiting until the last day. Of course, this relative finally has enough money to have a substantial emergency fund and is no longer living on the edge.
Investor Junkie says
@micheal: invest it but it depends upon what else is out there. Meaning are there any values to be found: stock market, RE, or business. I don’t think the stock market is cheaply priced, especially dividends, RE in the NY area isn’t so cheap, and I haven’t found any businesses to buy. So then yes it will go into prepaying the loan.
Investor Junkie says
Let me make this clearer Michael.. I want to make sure all retirement accounts are filled up, 529 accounts for my children (since they also are NYS deductible), a specific amount added in my taxable accounts yearly. Only then will I consider pre-paying the mortgage to other possible investments. I am following tax efficiency rules:
In my list prepaying the mortgage could be #9.
But also not hard set on this list either.
JP @ My Family Finances says
Fee income for banks is nearly 50 percent of their income these days. You need to take late payments and NSF seriously. More seriously than the miniature interest rates being given to savers. Still, I do all of these to a smaller degree and probably won’t change. At the end of the day, making money is making money and with bank interest, I don’t have to do anything to earn it.
David C says
It is a close cousin to the “Pay Bills As Soon As They Arrive”, but I would add it no longer makes total sense to wait until the very last moment (or day even!) to purchase your savings bonds. In the past the conventional wisdom was to purchase the bonds at the very end of the month so you would earn interest on the money in your account for almost the entire month before handing the money over to the government. That extra “float” however doesn’t really seem worth it anymore… particularly if you cut it too close and end up buying next month’s bond instead.
I’m no suggesting you have to buy your bonds at the absolute beginning of the month… but I see no reason to wait once say half of the month has already passed.
I agree! I didn’t include it in the post because buying I Bonds for the full $10k is nowhere as common as paying bills. Because of the large purchase amount, there’s still a little bit of juice if someone really wants to squeeze it. Let’s see, having $10k stay extra 15 days in a savings account that pays 1% will give you $10,000 * 1% / 365 * 15 = $4.11 before tax. Worth a small latte? It used to be $20.
The rules of money are changing, so we should change our money habits with these changing rules, otherwise we will leave behind.
With these low interest rated I ‘m taking advantage…. I’m leveraging my investment. In my for a personal loan I’m paying little money but with my investments I can make more money so I can earning money with other’s money.
This is great until the interest rates are low, you can benefit a lot more instead of putting money in checking account and let others benefit.