11. How to Choose a Rewards Credit Card

As mentioned in a previous blog credit cards can provide material benefits to their consumers. A few of which are recorded below: 

1. Aggregate all your costs 
2. Delays the payment due date to a future date.
3. It can provide a short term loan in the event of an emergency or miscalculation
4. Through rewards, it can give you money back for every dollar you spend. 
5. Can provide an additional layer of security between yourself and your cash. (Ie. losing a credit card doesn’t automatically mean someone can withdraw money from your account.)

Rewards and rewards cards in general are particularly interesting in that they can provide cashback, points, or another financial incentive to their consumers in exchange for each dollar they spend. In general, this is exciting because these discounts can seem meaningful and over time can be meaningful. But the challenge, with these types of cards comes two fold: 

1. How do I evaluate which card is right for me? 
2. How do I decipher the financial value of points or the other financial incentives they put in front of me over time?

Naturally, these questions are linked and in order to understand the first we have to understand the latter question. But before we get there, let’s first consider the elements that we must take into account to be able to select a card. 

1. Introductory Offers - The offer that credit cards provide the user to encourage them to sign up this can come in the form of points or cash. Ex. 200,000 bonus points or $250 cashback.
2. Continuous Rewards Offer - The per transaction rewards offer. For example, 2% cash back or 2x points etc. This is a critical element of the calculus to 
3. Annual Fees - The total annual cost of owning the card as charged annually by the credit card company. This can and often does go up marginally over time, so be conscious and aware of this over the years of owning a card, generally this is communicated prior to the change, but it is always important to keep an eye out especially for the magnitude of the change as this can change your ownership calculus over time. 

So what is ownership calculus anyway and how do I determine if the card is right for me. Well for starters, the calculation that everyone who owns a card should do is the following (This of course assumes that you can cover your credit card bill in full every month, which you should do): 

First Year Credit Card Value = Introductory Offer + [Expected Annual Spend x (% Cash Back)] - Annual Fees

Steady State Credit Card Value (No Intro Offer) = [Expected Annual Spend x (% Cash Back)] - Annual Fees

Why both? In some cases it may make sense to open a credit card for the intro offer alone and then downgrade to a no fee card prior to the second year if the First year credit card value is large enough. (This was popularized by the Chase Sapphire card offers of 2016-2017). In any event, if we only consider the steady state credit card value which should be the focus if you are owning the card for longer than a year, The best card for you is going to be the card that has the highest steady state Credit Card Value. 

One of the challenges that you may come across is establishing a % Cash Back figure for your spend. On a number of no fee rewards cards there is clarity on the amount of cash back with the offers being described in very explicit terms. For other cards, however,  this cash back is presented in hard to decipher points values. So for example, a card may offer double points on groceries and dining out. This conversion makes knowing what you are getting for each dollar you spend a bit tricky. 

The way you can figure this out is by looking up the rates and fees document linked to that particular card or accessing your current credit card account statement you are looking for rewards rates and spend numbers. For argument sake, I will use my own credit card statement figures. 

Actual or Expected Monthly Spend = $2,331 

Rewards Points = 5,361

Monetary Value of Single Rewards Point = 1.52 cents

Rough Cash Back per Dollar = (Rewards Points / Monthly Spend) x Monetary Value of Single Point 

Rough Cash Back per Dollar = (5,361/2,331) x 1.52 = ~3.5 cents or 3.5% cash back

This calculation is not only useful to inform our decision around which credit card to use but can also inform our spending in general. Bluntly speaking, you should never be spending money in the hope of accumulating points as you are losing 96.5% of your money in this example to do so. In some cases, an intro offer can change the calculus but generally speaking this is not the case.

Additionally, to further drive home the value of credit vs. debit cards this 96.5% loss is clearly better than the spend on your debit card which equates to 100% loss. By not using a credit card you are missing out on 3.5% of free money (net of the annual fee). Expanding on this example, we are talking about 3.5% a year minus an annual fee of $500.  

Steady State Credit Card Value (No Intro Offer) = [Expected Annual Spend x (% Cash Back)] - Annual Fees

Steady State Credit Card Value (No Intro Offer) = (12* $2,331 x 3.5%) - $550 = $429 

You are leaving $429 dollars on the table annually for no good reason. Again you should never be spending to accumulate points but if you have to spend a credit card is a great place to do it (assuming that you can pay your monthly bills). Check out NerdWallet for more information on top cards and the latest offers and follow this link on how to avoid racking up credit card debt. 

References

1. Soucy, Paul. “Best Credit Cards of September 2021.” Reviews, Rewards and Offers, 6 Sept. 2021, www.nerdwallet.com/the-best-credit-cards?trk=nw_gn_5.0.