This Is Why It's So Important to Have a Cash Cushion
A small amount of savings can help you avoid overdraft fees, but it's different than an emergency fund.
While it is important to make sure that you have an emergency fund, you also need to have a cash cushion. What does that mean, though? "The technical definition of a 'cash cushion' is a small balance you leave in your bank account to protect yourself against overdraft fees or insufficient fund penalties," explains Aja Dang, a YouTube creator who paid off $200,000 in debt in two years. "Personally, a 'cash cushion' is a set amount of money I like to leave in my bank account at all times before I start worrying about when my next paycheck might come."
Here, we asked Dang for more advice on establishing a cash cushion as part of your financial plan.
How Much to Save in Your Cash Cushion
Overdrafts can be expensive. Most banks charge $25 to $38, or potentially even more, for every overdraft. That can really add up if you have a lot of money coming out of your account and are already in a negative balance. "A cash cushion is important because financially, it protects you from fees or penalties that may occur if you didn't anticipate a bunch of withdrawals happening in your account at once," says Dang. "Mentally, it's the minimum you need in your bank account at all times before you consider yourself overdrawn."
The amount that you keep for a cash cushion in your checking will vary. "It depends on your spending habits," says Dang. "If you regularly budget and are on top of your spending habits, a cash cushion of $100 is good. If you're someone who is scared to look at their bank account, a larger cushion of $1,000 would be best." When you determine your budget, you should factor in what amount would work as your cash cushion. It's also a good idea to think about those little unexpected expenses you tend to accumulate such as gas for your car, last-minute groceries, or a co-pay for an unplanned doctor's visit.
When Not to Use Your Cash Cushion
Emergency funds are a smart money move if you want to take charge of your finances, but they are not the same thing as a cash cushion. Dang says that you need at least three to six months of your living expenses saved into an emergency fund. "An emergency fund is a large amount of money you save and use only in case of emergencies. If you have a reliable, nine-to-five job and always get paid every two weeks, your emergency fund can be three months of expenses," she says. "If you're an independent contractor or work off of commissions, you should keep five to six months of expenses in your emergency fund."
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