This is a guest post from Mr Credit Card from www.askmrcreditcard.com. Mr Credit Card reviews credit cards and knows the ins and outs of the industry. In this post, he is going to discuss some sound principals in managing your credit cards. Mr Credit Card has compiled a list of the best credit cards available. If you are looking to apply for a credit card, you can head over to his site to do your research.
Firstly, I would like to thank Jeff for giving me the opportunity to write this post. Managing and using credit cards wisely is all part of sound financial management but it seldom gets discussed because advisers and clients. So I would like to reveal some of my thoughts on how to go about managing your cards wisely.
Getting the right credit card for yourself and using them wisely involves some principals that are common to sound investment policies and money management. Here are some of them.
Understanding the purpose of the different types of credit cards
Many folks do not get the proper credit cards for themselves. The reason is that there are just so many credit cards available that researching is just too cumbersome for most people. I like to look at different credit cards just like asset allocation. Credit cards fall broadly into two camps.
The first group of cards are designed for folks who pay their bills fully every month. These folks should be taking advantage of rewards that these cards offer. For example, cash back rewards credit cards should be considered a staple in most people’s wallet, just like stocks should form the core of one’s portfolio (well, at least for most people). The cash rebates that you earn should be considered one’s dividends. In the investment world, the sound advice would be to get a “low cost” investment option for your stock investments because markets are efficient and nobody really beats the equity markets (after fees) in the long run. So make sure you get a “no annual fee” credit card that gives you travel rewards or cash rebates.
However, there are also alternative investments in the investing world. And they serve a different purpose and have their proper place in one’s portfolio. To invest in these assets, the SEC requires that you are an accredited investor (ie someone with over $1 million in network and/or have made $250,000 the last couple of years or expect to do so). You should be rather sophisticated and understand how these investments lowers the correlation in your portfolio. You also have to expect longer lock up periods and sacrifice some liquidity for higher expected returns.
In the credit card world, the alternative sector would be equivalent to the best credit card for miles or high end rewards cards. They are more costly. All of them charge annual fees. But they give some who is a frequent flier perks that they value – like making it easier to qualify for upper tiers, flight upgrades, free baggage etc.
If you carry a balance, then your credit card choice is more of a “liability management” issue. In the investment advisory world, liability management includes issues like having a home equity line of credit for emergencies, getting the best rate for your “boat financing”. In the credit card world, folks who carry a balance should consider paying these off ASAP. Credit cards with 0% APR balance transfer deals or low interest rate cards would be more appropriate. Be also sure to take advantage of interest free balance transfers.
Diversify your credit cards
In the credit card world, just like in the investment world, it pays to diversify. No sane investment would ever recommend a client hold just a few stocks. Instead, academic studies have shown that individual stock selection accounts for so little in an asset allocation outperformance.
The same rules apply to credit cards. You do not just want to have one card. But unlike investing where you really need a lot of stocks and bonds in your portfolio, with credit cards, you simply need a couple.
There are several levels of diversification. Firstly, you want to diversify by card type. So even if your favorite credit card is American Express or Discover credit cards, you should be another Visa or Mastercard as a back up. That is because not all places accept Amex or Discover. You also do not want to get a Visa and a Mastercard from the same issuer like Chase. Get a Citi Mastercard and a Chase Visa. That way, if you want to cancel a card or if the issuer wants to cancel your card, you still have another card with another bank.
Know Your risk tolerance and have enough cash
In the investment world, you never know your true risk tolerance until your portfolio take a big hit (remember 2008). For those who carry a balance, always budget in some emergency expenses. The reason is aside from things like your car unexpectedly breaking down, credit card companies can simply raise your interest rates. If you have no room in your budget, you could face some real difficulties here. As Jeff said, you must be prepared for an emergency.
Pay your bills fully
Other than your home (and even that is debatable), you should not be buying anything if you cannot pay in full. If you have to take financing, then wait till you have saved enough before you buy it. Buying something on credit is a recipe for racking up credit card debt.
Set Up Auto-pay
Your credit score is very important. A good score means you will pay lower rates on your mortgage and even your insurance. Set up auto-pay on your credit cards so that you will never run the risk of being late.
Combine Cards to earn more rewards
Just like in investing where combining different asset classes in your portfolio increases your risk reward profile, combining credit cards based on your spending habits can allow you to earn more rebates than if you just used one card. For example, you can combine gasoline credit cards (just use it for gas) and another cash back rewards credit card to earn rewards on other things. By combining them, you can earn more cash rebates.
Just like you should maximize your roth IRA contributions to maximize your wealth, you should also be maximizing the rebates that you can earn from credit card companies.
Occasionally use your cards which you hardly use
Due to the financial crisis and the massive damage to banks’ balance sheets, credit card issuers have canceled credit cards that have never been used to protect themselves. Very often, these cards have large credit lines and having them yanked from under you can hurt your credit score.
Never use your credit cards as the only source of emergency liquidity
Some financial advisors advocate having a home equity line of credit and extra credit cards as an “emergency line of credit” on top of your spare cash. While this works fine in theory, credit card issuers will not hesitate to slash your credit lines to just above your balance if you suddenly charge a lot to a card that was seldom used. Your emergency cash fund should be the first line of defense and only use your credit card as a last emergency resort.
Editor’s note: I fully support the notion that cash is king. I’m not a big fan of using HELOC’s or credit cards as your main cash reserve.
Watch what your kid spends on their credit cards
Under the new CARD Act, student credit cards cannot be issued to students with no income. If they do have income, the “total” credit limits will be capped based a their income. All this is good news. But if you kid is not working and have no income, then you will have to co-sign for them. Any late payments from them will ding your credit score. So keep a sharp eagle eye on those bills.
Well, I’ll end this post here and hope you have found these tips helpful.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.