One of the most common ‘personal finance strategies’ consumers have is to put their savings in the bank while running up credit card debt. Yet this is not the ideal strategy.
Now, don’t get me wrong. This blog post is not about the total evils of credit card debt. I am not going to argue that credit cards are the Devil’s plastic calling cards which should be avoided entirely. That is not my point at all. There is a proper role for credit cards. You can use them as easy to track financial devices for keeping a clear record of your spending. They also relieve you of a lot of the security and logistical hassles of having to lug around a wad of cash.
With that said, you have to use them the right way-this means you have to totally pay them off at the end of every month. There are no ifs, ands, or buts about that. For credit cards to serve you instead of the other way around, you have to totally wipe them off in a short period of time. Properly used, credit cards give you a lot of flexibility and much-needed spending power. You just have to use them the right way.
Credit card debt becomes a problem if you let the balance roll forward month after month. This is not free money. Not by a long shot. You have to pay interest and finance charges on that balance. If you don’t knock them out and it keeps piling up with new purchases, the interest accrued also increases. This is compound interest and it is working against you.
Sadly, many consumers think that as long as they have money saved in the bank, they are being financially responsible even though they are running very large credit card balances on a rolling monthly basis. This strategy does not pay off. Not even close. Read the guide below and see how this breaks down.
Low Bank Interest Rates
You get a lot of security by depositing your money in the bank. First and foremost, you can withdraw your money anytime you want. It doesn’t get more liquid than that. Moreover, your deposits are guaranteed by Federal Depositors Insurance Corporation (FDIC) up to a certain limit. You gain a lot of peace of mind by putting your money in the bank.
The problem is that this pace of mind comes at a price-a steep one at that. You get really low interest rates. To add insult to injury, this interest is taxed. You can easily make more money investing in riskier investments like stocks or certain bonds.
The Problem of Inflation
Believe it or not, your money rots. Every month your money is in the bank, it is worth less and less. Keep it in the bank long enough and your money won’t be able to buy anything. This is the iron law of inflation. Due to government monetary policy, inflation eats up our cash even before we spend it. If you keep your money in the bank, it will continue to shrink when adjusted for inflation regardless of the fact that the bank is paying you interest.
Knock out Credit Card Debt First
Putting the two factors together, it just does not make sense to run a balance on your credit card and have savings in the bank. The interest rates on your credit cards are easily several times higher than the highest bank savings or CD rate you can get. You are losing money every month you keep money in the bank while running a large credit balance.
You should leave some money for emergencies in the bank and use the rest of your balance to knock out your credit card debt. Get rid of that debt and keep it under control. This way, you have more room to move in terms of finally growing your money. The next step is to find the right investment with the risk profile that best fits your situation.