Contrary to what you might think, you don't want too much money in your savings account. There are a few reasons why that's the case. Most notably, savings accounts don't provide a very high return on investment, and there are better places to put money if you want it to grow and help you build wealth.
You absolutely do need some money in savings, though -- both for a rainy day and because chances are good there will come a time when you need to make purchases you can't pay for all at once.
The big question is, how can you decide just how much to put in savings? This is my process for figuring that out -- and it could potentially help you come up with your own system.
Start with your emergency fund
The very first thing I did was decide how large my emergency fund should be. Some experts recommend keeping three to six months of living expenses in savings, while others go so far as to suggest having enough cash to cover eight to 12 months of costs.
My husband and I are self-employed with varied income sources, two kids, and several homes. So, we decided that we're most comfortable having enough cash to cover six months of expenses. This doesn't mean we have enough to replace six months of income -- just enough to pay for our bills for six months if our paychecks were to stop coming.
We added up the amount we'd need to spend on the essentials, including groceries, housing, utilities, and other basic costs, and we have that much in savings. We keep this cash in a high-yield savings account because we need it accessible and don't want to worry about losing some of it in a downturn or having to sell investments at an undesirable time just to access it.
Consider other funds you may need
My husband and I also have a fund for home repairs because we don't want to rely on our emergency fund to cover these costs. Each year, we contribute 1% of our home's value into a separate savings account so we'll be prepared if we face big or small home expenses. We don't use the money every year, but if something major goes wrong -- like we need a new roof -- we'll have it.
You may also want a car repair fund in savings or a savings account earmarked to help you pay for a car in cash so you don't have to take out a car loan when your existing vehicle gets too old. You can estimate how much you'd need to replace your vehicle and how long the likely remaining life of your car is to decide how much to put into this savings account each year.
Again, having this money in savings is a good idea because it needs to be accessible, and it can prevent you from having to take out a loan or rely on a credit card.
Figure out how much you'll need for short-term purchases
Finally, I put money into savings if I am going to need it to purchase something within the next two or three years. I've made a list of big purchases I'm saving up for along with my projected timelines to buy them. Based on this, I've decided how much to transfer into savings each month.
For example, if I planned to buy a new sofa for $1,000 in one year's time, I'd put $83 per month into a savings account for that purpose. Since the money will be needed soon, I don't want to invest it and risk losing it when I may need it.
By adding up the amount of my emergency funds, my other funds, and my accounts to save for big purchases, I can decide exactly how much I should have in savings -- and the rest of my extra money goes right to my brokerage firm where it can do me more good for the future.