Do you have a bank account that gives you certain perks if you keep a minimum balance? Many financial institutions waive the monthly service fees if you maintain a minimum monthly balance in your account. Depending on the institution and the type of account, minimum balances range from $500 to $5,000. On most accounts, however, the minimum balance is generally $1,000 or $2,000.
Maintaining a minimum monthly balance can often waive the monthly fee associated with your services package. However, is this really a perk? Or is it really a cost?
Whenever you run into a situation where you are getting a cost savings, you should consider your opportunity cost. In other words, by keeping this money in a bank account at low interest, you forego other uses for that money. For example, you could use that money to pay down a loan rather than to keep the funds in your bank account to save the monthly service fees.
How much is a minimum balance costing you?
The best way to illustrate the cost of a minimum guarantee is to look at a couple of examples. When compared to a one year GIC, you can save much more by maintaining the minimum monthly balance in your account, than you would earn if you invested the amount in a GIC.
In his current situation, Jake Smith has a chequing account at a financial institution where if he maintains a minimum monthly balance of $1,000, his monthly fees of $6.50 are waived. As an alternative to keeping $1,000 or more in his account, Mr. Smith could invest these funds in a one year GIC, with an interest rate of 3.0%.
Over the course of a year, Mr. Smith’s annual savings by maintaining a $1,000 minimum balance is $78, which is simply $6.50 times 12 months of fees.
Alternatively, if Mr. Smith took that $1,000 and bought a 1 year GIC instead of keeping it in the bank account, it would earn $30 of interest over that year (before tax). If we take off taxes, he would have about $22 after tax.
In this example, it is to Mr. Smith’s advantage to keep the $1000 in the bank account to avoid the monthly fee of $6.50. It is in his interest to maintain the minimum monthly balance in his account until he finds an investment with after tax returns higher than 7.8%.
Janet Doe who a chequing account at a financial institution where, if she maintains a minimum monthly balance of $5,000, her monthly fees of $12.00 are waived. Let’s assume that as an alternative to keeping $5,000 or more in her account, Ms. Doe could invest these funds in a one year GIC, with a hypothetical interest rate of 5%.
In this example, it is to Ms. Doe’s advantage to invest in the GIC because the interest is higher than the fees paid. By keeping the minimum balance, Janet would save $144 in fees ($12 times 12 months) over one year. Alternatively, if Janet invested the $5,000 at 5%, she would earn $250 of interest, which is considerably higher than the $144 in fee savings. Even if we take off taxes, Janet would be better off to invest the money in a GIC and pay the bank fees.
Is it a perk or a cost?
The bottom line is to make sure you take the time to determine the benefit and the alternative to keeping a minimum balance in your bank account. The higher the minimum balance and the higher the rates offered by alternative investments, the more likely it will be that a minimum balance in your bank account will be a cost. Don’t be too quick to think of minimum balances as perks.
On the other hand, in the case of Mr. Smith, it was a perk and it was clearly advantageous to keep the minimum balance to avoid fees.
Today, there is a whole myriad of banking alternatives and there are many new high interest bank accounts that allow you to earn higher returns with lower or no fees. Shop around and you may be pleasantly surprised at what you will find. Bank accounts with a minimum balance may not be as much of a perk as you think.