How to Think About Credit Card and Travel Hacking

By Dr. Jim Dahle, WCI Founder

Lots of people, including high-income professionals like doctors, engage in what is popularly called credit card or travel hacking. The basic idea behind it is to work the system of deals offered by banks, hotels, airlines, and other companies so that you get all the positives with few, if any, of the negatives.

Done well, this can be a significant boost to your income, and it could allow you to direct more of your cash toward your financial goals, spend the same, and reach your financial goals even faster. You don't have to go whole hog either. It's OK to do just a little. There is some “free lunch” here, even if it isn't quite as free as it might appear at first.

The Easy Pathway with Credit Cards

There is an easy, minimal hassle pathway available when it comes to credit card and travel rewards. This is basically what Katie and I have chosen to do. We fly mostly on one airline, stay mostly in one chain of hotels when possible, and use cards we've had for years that offer 1%-5% back on what we spend. This takes extraordinarily little effort, but it does provide us with convenience, upgrades, and a discount of around 2.5% on just about everything we buy.

A simple example is that all of our gas goes on a 5% cash back PenFed credit card we got years ago (I don't think it's available anymore). We buy a lot of gasoline between long road trips, a diesel Super Duty truck, a full-size SUV, and a wakeboat. So, it does add up. And we get it all at a 5% discount. That's 25 cents a gallon when gas is $5 a gallon (and yes, we buy plenty of expensive gas). It wouldn't surprise me if those quarters add up to $500 a year.

The fun thing about credit card rewards is that they're generally considered discounts, not income by the IRS. When you consider your marginal tax rate, that's really more like an extra $1,000 in income a year. And it's not inconvenient at all. You get to pay in the most convenient way possible: the bill is paid automatically each month out of your checking account, and the “cash back” is automatically applied to the bill each month. Easy peasy.

The More Challenging (But Profitable) Pathway

That's not what most people are talking about when they're discussing credit card or travel hacking. The people who are really into this have a spreadsheet with 20 or 30 different credit cards on it. The big money really isn't in the “2% of all you spend cash back or points” cards. The big money is in the signup bonuses. For example, if you put $5,000 on a card in the first three months, maybe you get enough airline points to buy a coach ticket across the country. That might be a value of $800. That's like 16% back. Way better than 2%. And again, it's not taxable.

Then, you set that card aside (maybe even close the account) and work on the next one. As long as you don't screw up much, you never pay interest on any of these accounts, and if you pay fees, the rewards for doing so eclipse them dramatically. There are websites, blogs, podcasts, and Facebook groups dedicated to this art, filled with people who fly Delta One across the world, stay in the fanciest resorts, and come home two weeks later no poorer than they left.

More information here:

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The Downsides of Credit Card Hacking

Lest this all sounds like peaches and cream, we probably need to take a few minutes to discuss the risks and downsides involved in these techniques. As I mentioned at the beginning, if done well, there is some free lunch here. It just isn't as big a meal as many think.

#1 The Value of Your Time

It's easier for doctors and other high-income professionals to hit the minimum spend targets these cards require. They spend more every month, so hitting the $3,000 or $5,000 minimum spend can often be done in just a few weeks—not a few months like most people. However, this doesn't just happen instantaneously. There is some work involved. You have to do research; apply for cards and programs; read statements; close accounts; get on the phone occasionally; redeem rewards; and if you're smart, maintain a spreadsheet and calendar with all the details. That takes time, effort, and motivation, all of which are in limited supply for all of us. What is the opportunity cost of that time, effort, and motivation? For a doctor, it could be pretty high, whether it is seeing more patients and doing more procedures or spending more of your limited time with those you love and doing things that stave off burnout.

#2 You Should Probably Love to Travel

A big percentage of these rewards are travel-related. Some people like to travel more than others. I like to travel but not nearly as much as a lot of people, and I know some people who don't like it at all. When travel isn't a big reward to you, hacking doesn't seem nearly as fun. I wish everyone would have the time and money to do more than all the traveling they want so they can learn, as I have, how much travel they can do before they'd rather be at home. I assure you everyone has a limit. Mine is two international trips a year, which is probably about 1/3 of what Katie likes.

#3 Don't Screw Up

Every program is unique with its own set of rules and methods to game the system. It doesn't take too many screwups to eliminate the benefits. If you forget to pay a bill and start getting charged interest at 30%, you can wipe out an awful lot of months of 2% cash back or even an entire signup bonus. Fail to cancel a card in time and you may get another annual fee that eliminates most, all, or more than the benefit you were seeking. If you're going to do this with any degree of seriousness, maintaining that spreadsheet with all the details seems pretty critical.

#4 You Must Overcome the Additional Spending

Credit cards are a great way to spend for someone like me who has a hard time spending. It is simply less psychologically painful to pay with a credit card than it is with cash. If you're a natural hoarder cheapskate saver like I am, this can help you spend more of your money, hopefully on things you enjoy. Most Americans, including most high-income professionals who read this site, are not in that category. Their main financial problem is not that they don't spend enough. Their problem is they don't save enough. Studies are pretty clear that we spend more when we use credit cards, especially when we're thinking primarily about the rewards coming from that spending. A typical study in this space shows a credit card user spends 12%-18% more than someone paying cash. That seems about right to me. Even if you're getting 16% back on your spending, if you're spending 16% more than you otherwise would, you're not getting much of a free lunch. It's even worse if you're only getting 2% back.

“But I'm immune to that effect,” you say. Well, I've heard doctors say for years that they're immune to pharma advertising too. Yet Big Pharma keeps doing it. That's weird. Why are they wasting all their money? Hint: They're not. Banks, airlines, and hotels aren't wasting their money offering these programs either. Not only do you almost surely spend at least a little more when using credit cards, but most people will have a little screwup eventually (see #3 above).

#5 The Cocktail Party Effect

People love to talk about their speculative investments over cocktails. You know what other financial topic they enjoy? That's right, hacking. However, the effect is similar. Others hear only about successes, not failures. Nobody is going to mention that one month you forgot to cancel that card with a $500 annual fee. They just talk about flying first class to Istanbul. The equivalent of cocktail parties happens every day in online communities. It's easy for a blogger or podcaster to minimize the downsides too, especially if their revenue comes from hawking credit cards.

#6 Distraction

This might be the main thing WCI columnist Tyler Scott was worried about when he wrote the following (which was subsequently put out on social media by our team and heavily discussed in the aforementioned hacking communities):

It should be noted that Tyler has written about successfully using credit card points to book free international business class airline tickets and said he wasn't interested in doing it again.

You see, time spent learning about travel hacking is time you're not spending learning about personal finance, budgeting, investing, student loan management, retirement accounts, tax reduction, estate planning, and asset protection. When you objectively look at all those subjects and put them in rank order of importance, travel hacking isn't going to be at the top of the list. If you're not learning about travel hacking in addition to all that stuff, there's a real problem. Worse, some people might feel like they're doing great with all this financial stuff because . . . well, look at all the rewards they're getting! Meanwhile, they find themselves at mid-career with student loans, a big mortgage, a tiny nest egg, and plenty of burnout.

You're not going to travel hack your way to wealth. You've got to do the other stuff well, too. I'm sorry, that's just the way it is. It's a fun distraction. It can be a profitable hobby. But don't lose the forest for the trees.

More information here:

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The Bottom Line on Credit Card Hacking

Travel and credit card hacking is an optional activity that can add some pretty cool stuff to your life. But make sure you understand the downsides, and, for heaven's sake, make sure you're using that spreadsheet to keep track of it all.

What do you think? Do you travel/credit card hack? Why or why not? What are your favorite methods? What's the best deal you've had so far? 

The post How to Think About Credit Card and Travel Hacking appeared first on The White Coat Investor - Investing & Personal Finance for Doctors.