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A big challenge many people face when managing their finances is the temptation to use credit cards for everyday spending in pursuit of reward points. Instead of using a debit card linked to the account they use for their day-to-day spending, individuals often opt for their credit card to earn points. However, this can lead to significant setbacks and end up hurting you. Many find themselves overspending without realizing it, far outweighing any benefits gained from the points they earned. It's important for individuals to carefully weigh the risks and rewards before using credit cards for daily expenses to avoid financial difficulties in the long run.
If you were to work with a Certified Cash Flow Specialist to come up with a cash flow plan, you’d typically be directed to set up a separate spendable account that is apart from your committed expenses account (typically your current primary bank account).
Spendable accounts are designated chequing accounts for your day-to-day expenses. These are expenses that are high frequency, and more volatile and emotional, such as groceries, clothing, and entertainment. These kinds of expenses cannot be automated as they can change day-to-day, or week-to-week and while unpredictable, you can generally control them to an extent.
Committed expenses are predictable essential financial obligations, many of which do not vary month by month such as your mortgage payment, home insurance, and internet bill. Some of these expenses do vary, like gasoline, but all of these expenses are non-emotional. These expenses are best to have automated and are typically paid from an individual's main account that is separate from their spendable account.
Let’s dig into four reasons why credit cards just won’t work as a spendable account, or for day-to-day purchases.
1. Who benefits most from credit card points programs 🤔?
We are all so easily conditioned to want to get those points. You might think, “Hey, I’m going to spend this money anyway. I might as well get the points.” But it’s only a real win when you don’t overspend by even a few dollars. Why do we see a trend in offering more points on food spending? Because that expense is one of the highest risk areas of overspending for most of us. The grocery store is a high-risk spending environment and the credit card companies know that. They want you to be a little less vigilant and spend those extra dollars using their card.
Let’s also consider who is really benefiting from those points programs. Is it you? Or is it the credit card companies? What is the usual motivation for their card program design? It’s to get you to spend more. Remember, credit card companies earn their income when you carry a balance and pay interest, as well as merchant fees on every transaction. So even if you don’t rack up new debt, you could still be overspending and eating into other goals that you could be funding, all while credit card companies earn on your spending.
2. The pain of paying is diminished 💸
The pain of paying is an important experience that helps you manage your expenses more carefully because you’ll feel the impact of financial decisions as you make them. Credit cards are easier to overuse because that uncomfortable pain of paying is dulled. The timing of the act of spending and dealing with the actual cost is delayed, and it can do a number on your behaviour. When you use your bank account to pay, you see your balance diminish, which can slow you down and make you more conscious of your spending. Cash also provides a helpful pain of paying effect that keeps you more aware of your spending, though people are less apt to use cash for many transactions these days.
3. Combined psychological rewards 🧠
Not only do credit cards enable you to avoid some of the uncomfortable feelings that can come from parting with your hard-earned dollars to buy something, but making purchases this way exploits our innate cravings for immediate gratification. If you're also earning points in that transaction, you may get a second psychological win.
4. Timing exacerbates the issue ⌛
There is a double whammy when it comes to timing. First, it’s important that you have your spendable account topped up weekly with your recommended amount. It’s done weekly rather than monthly because it’s more in line with how we live and spend. Credit cards don’t work that way. Sure, you could lower your limit to your weekly spendable recommendation and then have the transfer pay it off each week. But the problem with that is your utilization (which is how much of your available credit card limit you are using at any given time) will be way too high because you’ll be at or near the limit each week. This is bad for your credit health. You could also go over the limit, which most cards will let you do, and then charge you an extra fee for it. No matter how low the limit is set, exceeding it will still cause these issues.
The second issue with credit cards for spendable costs is that transactions don’t settle immediately, so trying to manage a weekly amount is a disaster. Everything gets murky and before you know it, you’re off track and right back where you started, or worse.
The true cost of credit card points
Let’s explore an example. Your recommended spendable is $400/week. In a year, you’ll amass a total of $20,800 in transactions if you use it all. Surely it’s better to earn points on that spending, right? Let’s see how it works out.
- The card has an annual fee of $150
- The average points earned over the year is equal to 3% cash back
$20,800 spending
$624 value in points
-$150 annual fee
$474 realized annual value in points
If you overspent by as little as $9.12 per week, you’d totally wipe out the points value.
But most people will spend 15% more when using a credit card to make purchases, which would be $60 a week in this case. Many of us perceive ourselves as not being like most people. This phenomenon is called illusory superiority, where individuals tend to overestimate their abilities and qualities compared to others. So we’re all very likely to be like most people. What happens if you’re like most people? If you overspend by 15%, you’ll put an additional $3,120 on your credit card every year.
$20,800 spending
$3,120 overspending
$23,920 total spending
$718 value in points
-$150 annual fee
$568 realized annual value in points
This means that you’ll have spent an additional $3,120 to earn $568 in points. The net financial impact of using your credit card for spendable expenses is -$2,552.
The overspending behaviour triggered by the points inducement will cost you an extra $2,552 in a year. For many, this cost could be much higher. How much sooner would you reach your goal if you’d not accidentally overspent due to the promise of points?
If you use a credit card to earn $568 in points by spending an additional $3,120, you are not winning!
If you could manage not to overspend by a single cent, sure the credit card points might be ok, but this simply is not what happens. The risk of overspending far outweighs the value of the points on day-to-day spending. Stick to a no-fee chequing account with a weekly automated spendable transfer recommended by your CCS or advisor to be successful with a cash flow plan. Remember who’s doing the tempting and who’s really benefiting from credit card points programs.
How to use credit cards with a cash flow plan
If you want to earn points, you should use credit cards for committed expenses when possible. It’s important that if you use a credit card for committed expenses, you are also paying it off every month. It’s best not to use a card with a balance that you have to carry because you could lose track of how much you need to pay on it to cover all of your committed costs covered by that card. This will get confusing and could be expensive.
Another way to use credit cards and gain some points that won’t hurt you is by making short-term goal purchases backed by funds you’ve already saved. If you have decided to save for a trip you’ll take in nine months, you should be taking a specific amount of money and moving it over to savings each month. When you’ve saved enough, you’ll need to purchase your travel and accommodations using your credit card in most cases anyway. In this case, you can make the purchase on your credit card within the amount you have saved and then move the savings over right away to cover the cost. You get your points, but you don’t end up overspending. This strategy is too much effort for day-to-day spending, but great for things you have saved up for, as long as you don’t spend more than you’ve saved.
Points benefits that don’t hurt your finances
Points that don’t require the use of a credit card are a great way for you to save money or accumulate points that can supplement your expenses. Make use of all points programs that don’t require you to use a credit card. These programs can help build buffers in your spendable account when you cover weekly groceries with points, for example. You could even move the cash amount equal to the points you used over to your short-term goal account.
If you look closely, you’ll find there are plenty of articles that favour the use of credit cards vs. debit cards because of points. If you take a few seconds, you’ll find most of those posts are sponsored by, or feature ads from credit card companies. So take those articles with a grain of salt.
Credit cards definitely have a place in most of our lives, and their use can be incorporated as part of a cash flow plan. But you should never, ever use them for expenses that are considered spendable.
Would you like to learn more about how the spendable and committed expense concept works? Check out this session from our Financial Capability Series - Spending and cash flow. Then reach out to your advisor or a Certified Cash Flow Specialist to learn more about how a cash flow plan would work for you. Use your own behaviour to your advantage, and get more life from your money today.
About CacheFlo
CacheFlo is a financial education company that builds eLearning and tools to help financial professionals and individuals make behaviour-based changes, which allow them to get more life from their money. We want to make it easier for people to predict the impact of their financial choices before they make them.
About working with a Certified Cash Flow Specialist (CCS)
Certified cash flow specialist professionals go through enhanced cash flow planning training program to develop the skill set to deliver behaviour-based cash flow advice. They start the financial planning process with a cash flow plan to help you get more life from your money.
Whether you’re planning for retirement, saving for major expenses, or aiming to build wealth, a cash flow specialist can offer solutions to help get you on track to meeting your goals. Check out the CCS directory.
