Friday, July 13, 2012

When to avoid "miles" credit cards

Executive Summary
For most people, the answer is "always."

Introduction
Nearly everyone who utilizes credit cards is hopefully receiving some type of reward, whether it's cash, points, miles, or even charitable donations to their favorite cause or alma mater.  A common exception might be people who carry large balances on their credit cards, where, for instance, paying low or no interest while carrying a balance is a reward in of itself.  (Low interest cards don’t typically have great rewards programs.)

When it comes time to pick out a new credit card, there are a lot of options, but there’s also a lot of fine print.  When looking at cash back cards, for example, in addition to the % cash you get per transaction, you need to consider thresholds (the advertised % doesn’t kick in until you spend X), caps (the cash back stops after you spend Y), tiers (high % cash back on some items, but most purchases are low or nothing), and redemption options (redeem in multiples of $10, $100, etc).  Likewise, for airline miles credit cards, you need to consider blackout dates, expiration, transferability, participating carriers, etc.


Reward Example Scenarios
Even before you look into the details, the bigger question is, “how can I get most value out of the reward program.”  Let’s consider 2 very popular rewards credit cards (both without an annual fee):


provides 5% cash back at gas stations, drugstores, and 
supermarkets and 1% cash back everywhere else


provides 1.25 miles for every $1 spent on any purchase

According to the US Bureau of Labor Statistics, the average U.S. household spends just over $48k per year.  Of that, about $24k can reasonably be charged to a credit card.*  (Of the $24k, about $10k is spent on gasoline, groceries, and at drugstores.)  Using these rough estimates, an individual would net $640 in cash using the Blue Cash card and 30,000 miles using the VentureOne card.

Valuing Miles
The next question is how to value the 30,000 miles.  There are a few different ways to do this.  One is to just assume $1 per 100 miles, which is more or less what the airlines themselves claim.  In this case, 30k miles would be worth only $300.  Another way to value the miles is to look at what it can get you.  Airlines like to say that 25k miles gets you a free roundtrip ticket within the U.S.  Therefore, 30k miles would be worth slightly more than an average roundtrip ticket, say $400?  Now, anyone who’s ever tried to redeem 25k miles for a roundtrip ticket knows that this is near impossible (and if they can find a ticket for 25k miles, then the cash value of the ticket is likely less than $400).  More often than not you need 38-50k miles to redeem a roundtrip ticket.  Regardless, even if using the $400 assumption, this is still considerably less than the $640 yielded by the Amex.

What if we opt for a Visa or MasterCard instead of an Amex.  If you used the
CapitalOne NoHassle Cash  card which yields 1% cash back on purchases, your cash back from the above scenario would be $300.  In this case, you’d seem to be at a slight loss relative to the VentureOne card; but again, you have to take into account the following:
  • the likelihood of redeeming a ticket with only 25k miles (vs 50k miles)
  • the legitimate hassle of dealing with the airlines
  • taxes and fees that you have to pay out of pocket (which can be substantial for international travel)
  • the illiquidity of having miles (i.e., great than you have 40k miles, but if you redeem a ticket for 25k miles, now you have 15k just sitting there unusable)
  • the inflexibility of having miles (i.e., if you had the cash, you could spend it on airfare, or anything else in the world)
  • you may likely lose the miles  if  when the airline files for bankruptcy
I'm pretty sure Miles don't have seniority in bankruptcy proceedings

Furthermore, I’m being as conservative as possible by using a 1% cash back assumption.  If you don’t want an Amex card, your best bet might be the Chase Freedom which offers 5% cash back on certain categories (the categories change every 3 months and rewards are capped) and 1% on everything else.

Airline Cards
I haven’t yet mentioned airline-branded cards, such as the Citi AAdvantage card (American Airlines) or the American Express Delta SkyMiles card.  Unless you travel a lot with the same airline, these are your worst bets.  A typical airline-branded card will provide 2 miles for each dollar spent buying tickets on their airline and 1 mile spent on everything else.  For all the reasons mentioned above, your cash-equivalent rewards will be less than a straight up cash back card.  Even if you do travel a lot with the same airline, then you should consider having that airline’s credit card and using it only for airfare purchases; everything else goes on your cash back card.

Conclusion
Just like any good investment portfolio, your credit card portfolio should be diversified.  A well-diversified, high-rewarding credit card portfolio may contain 4 cards and look something like this:
  • American Express Blue Cash for the majority of your purchases, especially those at gas stations, drugstores, and grocery stores.  Amex cards can have higher interest rates, so only opt in if you’ll pay off the balance in full each month.
  • Capital One No Hassle Cash card (Visa or MC) to be used at locations that don’t accept American Express
  • If you fly a lot with one or two airlines, branded credit cards for those airlines.  The Chase MileagePlus Explorer Card (United Airlines) is a good example, and the free checked bags can easily make up for the annual fee.  (In lieu of an airlines card, if you consistently stay at a hotel chain then a hotel-branded card works the same.)
  • A low interest credit card if you make large purchases from time to time, such as the U.S. Bank Platinum Visa
*The conclusions I’m making in this blog are unaffected by the actual credit card spend by U.S. families.  The reason I present the BLS statistics is simply to provide reasonable numbers in the example.