The world changed in 1958, when Bank of America sent 60,000 people unsolicited BankAmericards. These cards, which later were renamed Visa, created an entire industry of credit hungry citizens willing to pay 18% or more just for the privilege of having credit.
It didn’t take long for the credit card companies to learn how to create an addiction and maximize profits – offer the card with a big limit “for emergencies only” and then put a visa terminal in many high end retail stores across world. With one swipe of the card, on a business trip or on a birthday, you’re locked into paying the companies for the next 5-10 years.
What we really need to know isn’t that these high-priced debt cards are dragging us down financially – we already know this. We need to know that paying them off is better than putting your money in stocks, bonds, real estate or any other type of investment. “Why is this” you ask?
All investments have three primary components:
1) Risk – the chance that you’ll lose your money;
2) Return – the amount you receive as interest, dividends, growth, etc.;
3) Liquidity – your ability to sell the investment quickly;
There is usually a trade off between the three. If you want 1) a high return, you either need to give up liquidity or you need to take on additional risk (investment real estate versus stock for example); 2) if you want low risk, you need to give up return or liquidity (Treasury bills or a 10-year CD) and 3) if you want liquidity then you take on risk or give up return (stocks or US government bonds). No investment has all three, except one.
You, more than anyone else, know if you’re a low risk investment. If you are (and I assume you think so) then paying your regular credit card payment is a forgone conclusion. By paying off your card early you are paying yourself, instead of the credit card company, the 18, 19, 20% return. Finally, liquidity. You can always recharge your credit card, drawing out the cash again, so early credit card repayment gives you liquidity.
You may be saying “Jonathan, I hear you but it does not feel the same to me. One is money in my account and one is money out the door.” Yes, but think of it like this. You (or your estate) will pay that credit card off eventually. If you do it when you retire, the interest you paid to the bank along the way could have been spent on other things, like investing! If you turn 65 and then decide to pay down debt with investment assets, unless your assets outperformed 18%, you will always come out behind.
If you know this one principle then you know more the 95% of the credit card debtors out there.
Jonathan Winter, CPA, MBA Author of “21 Ways to Get Out of Debt and Build Massive Wealth!” http://www.101MoneyTalk.info