The following is a post by MPFJ staff writer, Derek Sall. Derek is the owner of the blog, LifeAndMyFinances.com, where he teaches people how to get out of debt, save money, and become wealthy.
There is a big dispute going on right now between those that are earning money with credit cards and those that cut them up because they want to avoid overspending.
One side loves to use their credit cards all the time because they earn hundreds of dollars a year with their reward points, and they just simply don’t understand why anyone would forgo this money that the credit card companies are giving away, free of charge! Then, there are those that have seen families rack up credit card debts to the point where they were unable to pay even the minimum balance. Due to this fear of overspending, people decide to do without credit cards entirely and live with only checks, debit cards, and cash.
So who is right? Should you cut up your credit cards and live on a cash basis?
The Credit Rewards Perspective
I got my undergraduate degree in Finance, and I thought I was pretty hot stuff when I got graduated. After all my courses, I had an understanding of net present value, future values, interest rates, price-per-earnings ratios. I knew almost everything that there was to know about Finance! I know that there was such a thing as good debt and bad debt. One helped you build even more wealth than you had currently, and the other ended up depreciating your assets, but when used as a tool for wealth, debt could be a great thing.
On a smaller scale, credit card rewards fall into this realm of good debt and bad debt. Obviously, if you hold a balance on your credit card and are making high interest payments each month, this would be considered a bad debt. But, what if you pay the balance off each month, and are still earning those rewards? This temporary debt (which you probably would have incurred anyway) is allowing you to earn points that can soon be redeemed for actual dollars. This must be a form of good debt right? Well, for those that are playing this game, they certainly think so.
The Cash Only Perspective
When we picture those that avoid credit card use, they are often over 60 years old, have gray hair, and are totally ignorant as to how easy money is made. Why would somebody ignore the use of credit cards when they could earn an extra $300 a year in credit card rewards points? It just seems ludicrous!
This group of people though, may not be as ignorant as you might think. Instead, many of them have done their research and discovered that credit card spending can actually hurt your finances by a greater amount than the rewards. How could this be? It’s pretty simple actually. Just follow this logic for a minute.
Let’s say that you withdraw $40 from the bank to spend on whatever you wish during the week. As you walk around the mall or in your downtown square, that $40 is safely in your pocket, just waiting to be spent. Throughout the week, you see some shoes that you might want to buy, but then think about how similar they are to what you already have, so you pass on them. Then, you see some artwork that you think might look nice in the house. But no, there really isn’t anywhere to put it. Finally, you decide to spend some of your money on a nice meal with your friends and on a book that you’ve been dying to get your hands on. Throughout this whole process of spending your own money, you actually have been quite selective.
Now, imagine that instead of pulling $40 out of your own bank account, your grandmother hands you $40 to buy whatever it is that you want. As you walk through the mall, you see a video game that looks pretty awesome and the price tag is $40. Perfect, you buy the game without thinking twice about it. For some reason, the thought that you put into your purchase has severely decreased, but why? It’s simple. You did nothing to earn the money.
The same is true with your credit card. Because we are not literally pulling the physical cash out of our bank account and handing it over to the cashier for a purchase, the emotional aspect has been severely decreased. Even though we are still paying for an item with our own money, it feels more like the $40 that we got from grandma, so we spend it more frivolously.
Studies have been performed that prove this theory. When we purchase items with credit cards, we tend to overspend. And, over the course of the year it is entirely likely that our over-purchasing will exceed the amount that we received back in rewards.
So Where Do I Stand?
I imagine that you’re asking the question, “Well what about you, Derek? Do you use credit cards?” The simple answer to that is, “Yes”, but I believe that I am a special situation. I am what you might call an extreme saver. When I was in high school already, I avoided going out to eat at Wendy’s or Burger King because I knew I could eat for cheaper at home. So, instead of giving into the peer pressure of my friends, I would invite them to my parents’ house so that we could eat their food for free!
Today really isn’t much different. I am extremely content with the possessions I own and feel no need to buy anything extra. For this reason, I don’t feel like I am overly compelled to buy more when I have a credit card in my hand. Or, even if I am, it’s probably the difference of spending $5.00 instead of $4.00. The difference is probably so minimal that the overall effect is unnoticeable.
For many though, I think that it would be the right move to cut up those credit cards. If your credit card bill is constantly over $200 a month, then you are probably consistently overspending and earning nothing on those credit reward points. And, in the grand scheme of things, if you are striving to become wealthy (the right way), then what impact does $300 a year really have? Probably little to none. Don’t get hung up on the credit card game. Instead, use it as little as possible and focus your efforts on reducing your expenses and increasing your income. By focusing on the big picture day in and day out, you will certainly come out ahead!
How about you all? Do you use a credit card? Do you feel like you spend more than usual because of it?
Share your experiences by commenting below!
***Photo courtesy https://www.flickr.com/photos/434pics/3494630853
