Every month when you pay your bills, you’re subsidizing idiocy. And there’s nothing you can do about it. Your car insurance rates, for example, are higher because some guys think it’s a good idea to get drunk and see if their pickup truck can fly. Your health insurance rates are higher because those guys’ friends think a healthy lunch is a Carl’s Jr. Western Bacon Thickburger.
There is, however, one area of personal finance where other people’s bad decisions will finance your Caribbean vacation: credit cards. Unlike most financial products that are either bad (payday loans), or good (low-cost index funds), credit cards are as profitable or dangerous as you make them. They can either cause an awful downward spiral of debt and deprivation, or reward you with cash and free plane tickets. I recommend the second path.
In which case: Why would a bank be so generous? Because it hopes you’ll carry a balance on your card and pay lots of interest, as so many other Americans do. In fact, our fellow citizens collectively owe about $870 billion on their credit cards. This is great for JPMorgan, which took in around $5.8 billion in card interest last year. It’s not so good for card-holders. If you rack up credit card debt of, say, $10,000, you’ll pay around $1,500 a year in interest, depending on the rate.
But, for all the inherent risks of embracing plastic, there are perks, too. They help build credit, they offer fraud protection as well as perks such as rental-car insurance, and they’re a uniquely efficient, portable form of purchasing power. “How else can you carry $30,000 in your pocket, with no liability if you lose it?” says John Ulzheimer, the credit expert at creditsesame.com.
So: What’s in your wallet?
Get the debt out
The trick is turning credit cards from money vacuums into income producers. The first step is to keep the card free of debt. If you carry a balance, cut up that card. Too often I hear from people who carry a balance on a credit card even though they have enough money savings to pay it off. In other words, they’re paying around 15% to borrow money, while the bank pays them zero-point-nothing on their savings. Paying off that debt is an instant, guaranteed 15% return. No other investment gives you that.
If you need more flexibility in paying off your debt, take advantage of a 0% balance transfer card, but make sure to pay off the entire amount before the interest-free period expires.
Go for cash back
When it comes to rewards cards, most experts recommend cash-back cards because, well, what’s better than cash? The best cards will pay you 1.5%–2% of your purchases. Ulzheimer uses one for business, and gets around $50 applied to each month’s statement. That’s $600 a year — about the cost of an iPad.
Credit card terms frequently change, but at press time, one of the best deals out there is the Capital One Quicksilver Cash Rewards card, which pays 1.5% on all purchases and carries no annual fee. Ulzheimer favors the American Express Plum card, which gives 1.5% cash back and is aimed at small businesses.
Some cards vary the rewards depending on the type of item you’re buying—the Chase Freedom card, for example, offers 5% cash back on categories like gas, but that changes every three months. Regardless, if you have the patience, it could become lucrative.
Arguably the single best cash-back card is a no-fee Fidelity Awards American Express card, which deposits $50 into your brokerage account or IRA for every $2,500 you spend. You can compound generous rewards by investing it wisely.
Don’t forget the travel rewards
The problem with cards that reward you with points and perks is that they have no value until you actually cash them in. In the case of frequent flier miles, for instance, it’s notoriously difficult to get seats, and to get the dates you want you often have to spend double miles and book far ahead.
To get around that, avoid affinity cards that are connected with a specific airline. Instead, go for generic miles good for any ticket, any time. The Capital One Venture Reward card gives you two miles for every dollar you spend, plus a one-time bonus of 40,000 miles if you spend $3,000 in the first three months. To avoid the $59 annual fee, consider the VentureOne version, which is slightly stingier with the rewards. Chase Sapphire Preferred also offers a 40,000 miles bonus, gives one point per dollar spent (two points for travel and restaurant spending), and offers travel discounts. To estimate the reward value, chop off two zeros: Those 40,000 “miles” are worth $400 toward a ticket.
My logical personal-finance brain knows that cash in hand is the smart move. But stepping off the plane into the tropical sun knowing the ride was free? Priceless.