Thriving Millionaires

By Eric

There are many types of credit cards offering many types of perks – travel credit cards, hotel credit cards, specific retailer credit cards, credit cards with concierge perks, the list goes on. When evaluating these various types of cards and the benefits they offer, it can be challenging to convert the value of a first-class airline upgrade to that of early check-in and free breakfast at a hotel chain. You can equate these back to their retail value in dollars – but that doesn’t mean that the benefit is worth that much to you, which is where the conversion and comparison can get difficult.

For that reason, many people opt for the arguably simpler cash back credit card. Simpler doesn’t always mean better, but there can be value in simple. For those who don’t have an understanding of the mechanics of cash back credit cards, let’s start there.

Cash back credit cards allow you to receive a percentage of your total net spending back in the form of a cash deposit or credit to your account. The specific percentage varies by card, but it’s typical to find offers between 1% and 2%. Here’s an example:

Let’s assume you spend $1,300 in a month on a 1.5% cash back credit card. In the same month, you returned $50 of items to the retail store from which you bought them which was applied as a credit back to your account. We’ll also assume you paid the entirety of the balance when the bill came. For that time period, your net spending was $1,250 which would earn you $18.75 in cash back rewards. You could either request the $18.75 in funds via check or direct deposit, or you could apply the $18.75 against your next statement balance. It’s worth noting that some cards have certain redemption thresholds – generally about $25 – and you can only redeem the cash back once you reach that threshold.

As I discussed in a previous post about why you should use credit cards for every day purchases, I’m a big fan of cash back credit cards because they allow me to view the benefit from a few different lenses depending on which helps me conceptualize the benefit better.

Generally speaking, I view the cash back percentage as a coupon for X% back that is valid on every purchase I make. Mentally, that’s like having a discount card that gives me X% off at the grocery store, online shopping, my cell phone bill, and even airline travel. I don’t need to juggle which card to use for what purchase because I get that discount on all transactions.

Another way to view the cash back benefit is through the lens of lowering my credit card bill. If we use the example above to continue the illustration, my credit card bill would be $1,250 each month assuming the example month was typical. When I apply the cash back to the account, my monthly bill drops to $1,231.25. That may not seem like a large decrease, but over the course of a year, that will save me $225 in credit card payments. Money that I can use to make other purchases, save to build an emergency fund, or invest to grow.

The third lens that I find valuable to apply to cash back credit cards is the ability to make one “free” purchase each year. Rather than thinking of the $18.75 per month as reducing my credit card bill, I can look at the annual lump sum of $225 and have license to splurge on a $225 item that I would be buying for “free”. This allows for a guilt-free purchase of medium size.

Because these three lenses are simply different ways of mentally viewing the same benefit, you can’t apply all three lenses at once. It’s the same amount of money regardless of how you’re looking at it – but the key is to find whichever mindset allows you to find the most benefit and have a healthier view of your personal finance situation.

Cash back cards are “generalists” whereas other credit cards are “specialists”. A travel credit card will earn a higher de-facto percentage of savings on air travel or hotel stays – but it won’t do much for you at the grocery store or when doing online shopping unless you do a decent amount of travel and plan to bank and redeem the miles earned on purchases.

There isn’t a right answer to which credit card is the best. The key is to find which credit card works best for you given your lifestyle and personal finances. If you choose to use a cash back credit card, it’s worth shopping for the best percentage before applying.

The difference between a 1% cash back card and a 2% cash back card on the same $1,250 monthly net spending is the difference between $150 and $300 per year in cash back. And if you plan to use a cash back card over a period of years, let’s say 10 before you potentially find the need to change the type of card you carry, that difference is $1,500. While $1,500 may not seem like a massive amount of difference over 10 years, the point is that you’re leaving this money on the table for purchases you would have otherwise made anyway.

Patrick’s Thoughts:

As Eric points out above, one of the most important factors in choosing a credit card is evaluating your lifestyle and choosing one that best fits your situation. Does a travel card really make sense if you don’t plan on doing any travel? Probably not. Does a hotel card fit your lifestyle if you prefer to stay at AirBnBs? Probably not. If you move around a lot, do you want a credit card tied to a particular airline? Probably not. The list goes on and on, but you get the point.

That is where the cash-back card comes in. Do you want cash back on your purchases? Of course. There is really no situation where you are not going to want money flowing back in your pocket. This is really the key benefit of the cash back card. It’s never going to go out of style and it’s never going to be counter-productive.

The difficult part about it is that the card you pick needs to align with your lifestyle. Eric’s examples above illustrate that even though the benefits may not seem huge, it’s money you’re leaving on the table if you don’t take advantage of it. So how do you maximize the benefits you are getting?

What I’d like to do in my response today is highlight a couple different current credit card offers and specific life situations where you could see tremendous benefit to your budget.

Blue Cash Preferred Card by American Express

Let’s say you’re a family of four looking for a cash back card. You’d probably start by evaluating the areas where you spend the most money. One of the first areas you would look would be at your grocery budget. The average family spends anywhere between $150 and $300 on groceries a week. Assuming you’re on the lower end of that spectrum, that would equate to $7,800 a year.

That’s where the Blue Cash Preferred by American Express comes in. First of all, it offers 6% cash back on groceries for the first $6,000 spent (1% after that). Just on your grocery budget, that’s $378 back in one year! The other great benefit of this card is 3% back on gas. Families often have to do a significant amount of driving due to kids activities and road trips. Assuming an average of $3,000 spent on gas per year, that another $90 back. Now you’re at a total of $468 back just on two spending categories. That’s free money you’re leaving on the table if you’re using cash or a credit card with no rewards.

Discover It Cash Back Card

If you’re looking for lots of flexibility, the Discover it Cash Back Card is one of the best choices out there. The way this card works is you pick a particular spending category each quarter that you would like to earn 5% rewards for. On all expenditures up to $1,500 in that category you will earn 5% cash back.

The real benefit here is that you can change up the rewards category on a quarterly basis. If you don’t have as regular of spending patterns this can be a great choice. Even if you do spend in the same areas, you can just retain the same category and continue to earn cash back on it every quarter.

One other key benefit is that Discover will match all the cash back on your first year with the card.

Other factors to consider that I didn’t discuss above are the sign up offers and the annual fee. Lots of cash back is great, but any annual fee should be factored in as it’s work against you. With the two examples above, all I’m trying to illustrate is that you should choose your cash back card wisely. Different cards will have different benefits, and you should leverage the ones that best apply to your lifestyle.