Although credit cards seem to be falling in popularity with millennials and younger people, there is no doubt that the ‘fantastic plastic’ still accounts for a large chunk of our spending as Australians.
Many of us will have been sent a credit card invitation on our 18th birthdays (or maybe 21st if you’re of a certain generation) and the availability of credit forms a large psychological factor in how much money we perceive we may have – and thus, how much we spend. Even if young people are shunning credit cards, they are taking up the slack with ‘buy-now, pay-later’ services like Afterpay Touch Group Ltd (ASX: APT), which is almost the same thing.
Credit cards are big business, with the Australian industry estimated to be worth more than $50 billion each year. Banks only make a profit on a credit card if the holder doesn’t pay the balance off each month and is subsequently charged interest, so clearly most people aren’t managing to pay off their balances. With interest rates usually between 10–25% on a typical credit card, of course this is going to result in someone getting rich. Even Warren Buffett has averaged an investment return of around 20% throughout his career, so it blows my mind that people let banks like Commonwealth Bank of Australia (ASX: CBA) ‘Buffett’ them with these usurious rates.
Indeed, one of the revelations to stem from last year’s Royal Commission into misconduct in the financial services industry was banks’ over-enthusiasm in offering high credit limits to customers who simply couldn’t afford them.
There has since been a crackdown on this kind of behaviour and banks like Commonwealth seem very ‘remorseful’ that it was allowed to happen. But just remember that it’s an absolute honeypot industry – sure it smells sweet, but don’t get too sticky.
Having said this, there are ways of using credit cards to your advantage. Since banks know they make an extreme return on investment with their credit card businesses, they offer generous perks to draw customers in, such as Frequent Flyer points from Qantas Airways Limited (ASX: QAN), cash-back offers and free insurance (the list goes on). If you never pay a cent in interest, but use your card to take advantage of these perks, it is possible to make a tidy profit off the bank’s back (which always feels nice).
Remember credit cards are fire and not to be played with. If you want to go down this road, I personally think that its only worth it if you vow to never let a payment draw interest and replace only everyday spending with credit, rather than taking the plastic on the odd hedonistic shopping trip. The perks can be worth it, just don’t get burned.
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Motley Fool contributor Sebastian Bowen has no position in any of the stocks mentioned. The Motley Fool Australia owns shares of AFTERPAY T FPO. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.