Credit cards 101: an optimization strategy for starters
tl;dr • Make sure credit cards are for you first • You can save a lot of money by using rewards credit cards • Great returns can be obtained with a simple 2-3 reward cards strategy
I remember quite vividly today how I got my first credit card, about a couple of decades ago. I was closing on my first car when the salesman offered me their brand's card which had a sweet deal of 5% cash back on all purchases. Here's the caveat: the cash back could only be used for buying new cars of that brand. Not many people buy new cars every year, so that's probably not a great card for most, but I immediately recalled that my dad had been buying cars of that brand for his business quite regularly to be used as delivery vehicles, so I knew I would have an easy way to cash those credits out. And so my journey began.
First things first, should you have credit cards at all?
Credit cards can offer tremendous benefits over other forms of payment in terms of convenience, security, and – just as important – the ability to earn outstanding rewards and potentially reduce one's cost of living.
However, there are a couple of simple rules of thumb one must (absolutely must!) be able to follow in order not to turn credit cards into their worst financial mistake. If you can't follow these rules, well, you are probably better off staying away from them (see A debit card everyone should have).
The key is to understand that credit cards should never be seen as a convenient way to get a "quick loan". Interest rates are among the highest around, and they’ll quickly eat away any reward one ends up earning. With that said:
Rule #1 – Think of your credit cards the exact same way you would think of your debit cards: never mind the credit limit, if you don't have the money in your bank account to pay for it, simply don't use the card. Period.
Rule #2 – Always pay your balance in full and by or before the due date. Don't even bother comparing interest rates and late fees between credit cards, thou shalt never incur such costs. Ever.
If you can clear these rules, you are good to continue reading.
How many cards should you have?
I currently hold more than 20 open credit cards. Yes, I know, I do over-optimize, but I'd say that to me credit cards also work as form of entertainment, just like the Magic The Gathering card game used to be in my nerdy teenage years, it awakens in me a similar excitement of discovering new "combos" to build an "unbeatable deck". The main difference now is that I save money when I play this game.
With that said, I usually tell people that Pareto's 80/20 distribution applies here too: you can probably get 80% of the rewards I get with just about 20% of the credit cards I have. In this article I'll try to summarize a few ideas for a reasonable credit card strategy for starters, or simply for people who don't feel very comfortable holding a whole lot of them.
Which credit cards should you have?
The most honest answer to this question is it depends on your profile, or your ability to derive value from the rewards you'll earn. A great card for John won't necessarily be as great for Mary, just like my first credit card only made sense to me because I had a clear way to cash the points out. Also, you need to adapt your strategy to the cards that are available in your country. The following recommendations are based on the U.S. market.
Here I'll be focusing on 2 categories which many people use: groceries and dining, plus I'll be talking about cards for uncategorized spending as well. Getting cards with reasonable rates of return on theses categories will give you a great start.
Also, for simplicity, I'm focusing mainly on the earning rates and zero/low annual fee aspects of each of these cards, intentionally skipping other important aspects (e.g. sign-up bonuses, travel perks). The suggestions below are far from being exhaustive, but I hope they deliver a good example of how simple it can be for one to get their feet wet with credit card rewards.
Groceries: AmEx Blue Cash Everyday and AmEx Blue Cash Preferred
These cards are very similar, both give you cash back on the first $6,000 you spend in groceries every year.
The AmEx Blue Cash Everyday has no annual fee and pays 3% cash back on groceries, while the AmEx Blue Cash Preferred has a $95 annual fee and pays 6% cash back on groceries.
The break even is at $3,167 spent per year (or about $264 per month) in groceries. If you spend less than that, you'll be better off with the Everyday, whereas if you spend more than that the Preferred will render you the highest return which, accounting for the annual fee, effectively give you a max of 4.4% returns if you spend the whole $6,000.
Dining: Gemini MasterCard, Chase Freedom Unlimited and Capital One SavorOne
None of these cards charge an annual fee, and all of them give you 3% cash back on dinner spending.
The Chase Freedom Unlimited also pays 3% cash back on drugstores, and points can be combined with other cards in the Chase Ultimate Rewards family of cards (e.g. Sapphire Preferred and Sapphire Reserve), which makes them worth even more when redeemed at the Chase travel portal.
Another advantage of the Chase Freedom Unlimited is that it also works as a fair general spending card as it pays 1.5% cash back on all other purchases, while the Capital One SavorOne and the Gemini MasterCard pay only 1% on uncategorized spending.
On the other hand, both the Gemini MasterCard and the Capital One SavorOne charge no foreign transaction fees, a very important thing for those who intend to use their cards abroad.
Additionally, the Gemini MasterCard pays 2% cash back on grocery spending, which makes it a reasonable alternative for those who don’t want to carry too many cards.
Another interesting thing about this card is that rewards are paid in the form of cryptocurrencies like Bitcoin, which may be either a pro or a con depending on where you stand on the subject. Signing up for a Gemini account is free and enables one to trade multiple cryptocurrencies.
General/uncategorized spending
There's no reason why one shouldn't carry at least a simple 1.5% or 2% cash back card in their wallets, and the good news is that there are a lot of them available.
My preference today goes to the SoFi Credit Card, as not only does it pay 2% cash back on all purchases, but it also has no foreign transaction fees, making it really good for international expenses. If I were to have only ONE card in my wallet, this might be it. A little caveat is that for the rewards to be worth 2%, one has to have a SoFi Banking account, which is not a bad hoop to jump through, especially as the account has no fees and pays good APY.
Other cards that pay 2% back are the PayPal Cashback MasterCard, Wells Fargo Active Cash and the Citi Double Cash. All of them do charge foreign transaction fees, though.
An interesting aspect of the PayPal Cashback MasterCard is that also pays 3% cash back on all PayPal transactions, which can have a lot of value for many.
Runners-up here would include the Capital One Quicksilver, with 1.5% cash back and no foreign transaction fee, and the above mentioned Chase Freedom Unlimited, also at 1.5%.
Doing the math
Here’s a quick example – with pretty much arbitrary numbers – to illustrate. A household that has average monthly expenses of
$400 in groceries, at 6% cash back (minus $95 AmEx Blue Cash Preferred annual fee)
$300 dining out, at 3% cash back
$1,200 in remaining expenses, at 2% cash back
is effectively earning $49.08 in cash back every month, an average of 2.6%, for a total of $589 every year which could be used to beef up their savings account!
Bottom line
It doesn't take a whole lot of effort to hike up substantial amount of credit card rewards by just using them for expenses you’d already incur anyway. Ultimately, these have the potential of lowering your cost of living by a few percent which truly add up in the long run.
There's a whole lot more in the credit card rewards world that was intentionally withheld from this post. A next step I would suggest would be to look into travel rewards credit cards. These can take your game to the next level with higher return rates and sign-up bonuses, perks like airport lounge access and airline benefits – but also higher annual fees as well. The Chase Sapphire Preferred, Chase Sapphire Reserve, Capital One Venture X, and even the American Express Platinum are some of the cards I would recommend.
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Disclaimer
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This is not financial advice. I am not a certified financial planner or advisor, just an ordinary guy trying to sort out his own finances, sharing his perspective with no guarantees. Use the information provided at your own discretion. You are highly encouraged to do your own research before making any personal finance decision.