Allow me to create the proper mindset for this article.
As some commercial once said, “you work hard for your money, make your money work hard for you.” Or maybe I’m thinking of a Donna Summer song. Regardless, you should try to squeeze every penny out of your money, at every opportunity.
The obvious example of this is keeping your money in investment vehicles. Presumably, you set aside money in retirement accounts so it will continue to grow. And even though savings accounts earn paltry interest these days, you likely maintain a savings account so your money doesn’t just sit in a checking account earning nothing.
Way back when savings accounts earned about six percent interest, my accountant chastised me for having $10,000 sitting in my business checking account. I defended myself by saying that the amount of money constantly fluctuated in the account, up to $10,000 and down to zero, and that when it went over $10,000, I transferred the excess over to the business savings account. I said that the small amount of interest I would earn by being more aggressive about transferring funds in and out of savings would not be worth the hassle. In response to this, she uttered the immortal words that forever altered my financial thinking. “If you saw it on the street, would you bend over to pick it up?”
Words to (financially) live by. If you’d pick it up off the street, then you shouldn’t ignore it in your finances. But while many are fanatical about putting their incoming money to work, they completely ignore ways to benefit from the outgoing money. They leave money on the street in the form of a cash tax.
What is a cash tax?
Imagine you go into a Best Buy to purchase the latest, greatest MacBook Pro for $6,000. (Yes, the one with the i9 processor and amazing 8TB SSD really does cost that much.) You go to the register and say that you are going to pay with a debit card. You are financially responsible, and you saved up for this Apple beauty. No credit cards for you. The cashier responds with, “No problem, but there is a 10% cash tax, so you’ll need to pay $6,600 for the $6,000 MacBook.”
It may sound crazy, but that is precisely what you’re doing when you pay cash, instead of running the purchase through a credit card. And I use the term “running through” intentionally because I’m not suggesting that you finance the purchase. Running a balance on a credit card, and paying the concomitant interest, is equally as crazy as paying the cash tax (unless you use a zero percent credit card, but that is a topic for another day).
Here are the numbers.
Even a no-frills cash back card like the Citi Double Cash credit card pays an unlimited 2% cash back on all purchases. With no other effort beyond using this credit card to buy the MacBook, you would have reduced the price to $5,880. And this is by no means the best deal. The Alliant Cashback Visa Signature Credit Card offers 2.5% cash back, and sometimes offers 3% cash back for the first year. That would reduce your MacBook to $5,850 or $5,820, respectively.
Credit cards like the Chase Freedom or Discover have rotating categories that offer 5% cash back, and Discover matches any cash back for the first year. If you timed your purchase to when it would fall under a 5% category, your savings could be as much as 10%, bringing the price down to $5,400. Six hundred dollars off just for using plastic instead of cash.
But wait, there’s more.
Many credit cards, the Citi Double Cash and Chase Freedom included, allow the cash back to be converted to points for travel (more accurately, the Chase Freedom gives you points, which can be used as cash).
The people who collect travel points as a hobby, find ways to wring out every penny, and although the nominal value of a point is typically one cent, it can have a much higher value when applied to travel. As a real life example, what would you pay for a round trip, first class flight to Hawaii, from anywhere in the 48 states? If you picked up a Citi Premier card in anticipation of this expensive purchase, you’d end up enough points for TWO first class, round trip flights to Hawaii, or FOUR in coach. Incredibly, as I explain in this article, using the Citi Premier credit card for this purchase would set you up for a system that would let you fly first class to Hawaii every year for the rest of your life.
So whether you decided first class sounded good, or opted instead for coach, assign a value to that, and that is the cash tax you would pay if you purchased the MacBook with cash, times two or four, respectively. (If you need some guidance, first class from New York runs about $2,100.)
But wait, there’s more. (Sorry if that’s getting annoying, but I think it really drives home the point.)
Your fancy new MacBook comes with a one year warranty. To make that three years, something you might want to do for such an expensive item, the extended care warranty from Apple is $379. Many cards offer an extended warranty of one additional year, and the Citi Costco Anywhere Visa adds two years. And by the way, if you are an Executive member at Costco and buy the MacBook there with your Costco Visa, you’ll earn 4% cash back ($240). Between the free extended warranty and the cash back, that’s a savings of $619.
But wait, there’s more. (Last time, I promise.)
Some cards offer Purchase Protection. The Chase Ink Preferred card offers $10,000 of protection against damage or theft (up to $50,000 per year) for 120 days from date of purchase. If you pull your MacBook out of the box and immediately drop it on the floor, you’ll be glad you bought it with a credit card instead of with a debit card.
The cash tax can’t be denied.
This is my beef with the so-called financial gurus who advise against any use of credit cards. They sell their books and courses by preaching that people cannot be trusted with credit cards, because they will spend themselves into debt or, at a minimum, will spend more money overall because using plastic takes the pain of spending out of the equation (although I have never understood how a debit card is any different pain wise). Credit cards are like power tools. They can cause severe injury if you are not careful, but if used properly they make life better.
With many people, it is certainly true that credit cards can be a problem, and I will even concede that if I had to count out sixty, $100 bills to purchase a $6,000 MacBook, that exercise would better emphasize to me that I was spending a ton of money for that laptop; more so than putting a credit card in a slot. But none of that takes away the cash tax.
On the low end, between the 4% cash back and the free extended warranty, buying our hypothetical MacBook with cash adds $619 to the cost. Moving up the scale, if you timed the purchase when it fell into a 5% category in the first year of your Discover card, then you would have saved about $900 (but you’d give up a year on the extended warranty). Continuing on, if you agree that the free flights to Hawaii via the Citi card have a tangible value, then between the forfeited flights and uncovered loss when someone steals the MacBook out of your car, paying with cash could cost you $10,000 more! And finally, taking it to the absurd, but still completely accurate limit to emphasize the point, if you decided you would rather pay cash for the MacBook to the exclusion of getting the Citi Premiere card, which would have put you in a situation where you could have earned lifetime trips to Hawaii, and assuming you have, say, another 50 years on this beautiful blue marble, then you paid $100,000 more than you needed to. That’s one expensive computer. And you’ll never meet and begin your life with Rachel Bilson (a reference you’ll need to read the other article to understand).
Instead of giving that all up out of some fear that you can’t be trusted with credit cards, why don’t you just take the risks of credit to heart, and choose not to fall prey to those risks? When I needed to lose some weight, all the diet experts I read advised that one should not weigh every day, because your weight can fluctuate for any number of reasons, and you might get discouraged if you witnessed an up tick of the scale. But how about if I just take that knowledge, and go ahead and weigh every day, for the information that will provide, understanding that I should not be discouraged if I see said up tick? I found that by weighing every day, I prevented any weight gain because I always knew where I was. No more of those surprise moments when I have to struggle to button my pants.
By the same token, some argue that all of the credit card benefits like extended warranties, purchase protection, and even travel points, are all illusory, because most people never use them. Again, simply choose not to be one of those people. When I buy a warrantied item, I put a sticker on it, indicating the card used, the purchase date, and the date the extended warranty expires. The process takes about a minute. If the item fails, I have all the information I need for a refund or repair. I have used my credit cards’ extended warranties on multiple occasions. (For some reason, I have really bad luck with inkjet printers.)
Spending cash is a failure.
You are best served by putting ALL your money to work, both incoming and outgoing. Unless it is just unavoidable, I try never to pay a bill directly from my bank account. For example, there is no extra charge to pay my gas and power by credit card, and doing so earns me the equivalent of a 5% discount on those two utilities. On the other hand, my water company charges a credit card fee that would more than wipe out any potential savings, so I have to begrudgingly pay that from my checking account.
I admit it’s all somewhat crazy. A business incurs a fee to accept my credit card, and if everyone uses credit, then it necessarily increases the price of goods and services. But for now, I’m not going to be the one to pay thousands in cash taxes as my silent protest against this economic reality.
I will say again. If, through your history and self-reflection, you have determined that available credit is just too much of a temptation for you, then $619 is a small price to pay to avoid a downward spiral into debt. But understand that the cash tax involves far more than our hypothetical MacBook. On every purchase you make and bill you pay, including gas, groceries, restaurants, streaming services, and cell service (if you pay your cell phone bill with a credit card, some offer up to $600 in repairs for free), you’ll be paying a cash tax. Being responsible with credit is really just a matter of deciding to do so. As proof, Dave Ramsey has a ritual where listeners who have gotten out of debt can call into his radio show and do the “Debt Free Scream.” Every one of those screams represents someone who was in debt, and at some point decided to change their mindset in order to get out of debt. Maybe it’s time to take it to the next level. Maybe it’s now time to make the decision to be responsible with credit, and never go into debt, in order to avoid the cash tax.
And as Monty Python says, now for something completely different.
I add this final thought to respond to a common response I hear when discussing travel points. Above, I used the example of getting a Citi Premier credit card, which comes with a sign up bonus of 60,000 points. Combining that bonus with the points you’d earn from the purchase of the laptop, you’d end up with 66,000 points, which will get you to Hawaii two or four times, depending on how you decide to fly.
But while I referred to those flights as “free,” some will correctly argue that they are not actually free, since the points have value. You could take those same 66,000 points, and cash them in for $660. Thus, from a technical standpoint, by opting instead to use them to fly to Hawaii, you are in a sense spending $660.
That logic is fine as far as it goes, but in this article I was discussing how paying cash keeps you from earning that $660 in the first instance. I think it is therefore fair to say the trips are free, since you would not have otherwise been able to take them, and you would not have earned the points for the $660.
I also talked about how travel points can represent a multiplier far in excess of one cent per point. In this case for example, the $660 worth of points buys $4,200 worth of travel, giving each point a value of over six cents. The point hobbyists nerd out over this stuff, and seek out trips with high point values for bragging rights.