Credit Cards and the Art of Leveraging Your Cash Flow

“Credit Cards and the Art of Leveraging Your Cash Flow” is a post by Adina J in which she admits to finally figuring out how credit cards are really supposed to work.

This will be an odd confession to make, but here it is: for a long time, I didn’t know how credit cards worked. I understood the rules, but I didn’t grasp that credit cards could be useful to a financially responsible person. I failed to realize you could use them for leveraging your cash flow. Needless to say, I didn’t use credit cards to their full potential as a result. That’s not as bad as misusing them, but it’s not smart, either.

I’ve long understood the general concept of ‘leverage’ but I was confused about credit cards because they offer leverage for a mere month at a time. We all know what happens if you don’t pay your credit card off each month – wham, 19% interest rate (not including possible fees). That’s not something I’d risk. I was taught from an early age to never buy things I couldn’t pay for out of pocket, houses excepted. As a result, I don’t buy things unless I already have the money sitting in my bank account. Contributing to my previous lack of knowledge: my first experiences with credit cards happened long before the concept of meaningful rewards reached the depths of our northern enclave. To wit, I collected “points” on my oldest VISA for the better part of a decade. My reward? I hope to qualify for a flight to Calgary in the near future. I kid. Kind of. It took me a while to realize that the world of credit card rewards has evolved (hello, Scotia Momentum Infinite! Sign up before February 28th, 2013 and get a FREE $100 Gift Card from RateSupermarket.ca), and by then I’d finally figured out the real utility and value of credit cards.

As Joe points out ad nauseum (he’s likely inserted no less than three credit card ads so far), there are better and worse credit cards out there. Let’s ignore the differences for a moment. All credit cards, except for prepaid and secured ones, offer the utility I’m talking about. They help you in leveraging your cash flow.

“But wait,” you say, “I thought you said you understood leverage before?”

It’s true. But what I didn’t fully comprehend until recently was the importance of cash flow. (Editor Joe’s Note: somebody needs to read Control Your Cash!)

For (too) many years, I kept large chunks of my savings in, well, plain old savings accounts. This meant that, during that time, there was little difference between my “chequing account money” and my “savings account money”. Neither was earning me much in the way of interest. If, in any given month, my expenses exceeded my income, I could easily pull money out of my savings account. No worries about liquidity or paying commissions to sell investments. When your financial affairs are arranged in this manner, it’s easy to miss the significance of cash flow.

Assuming your net cash flow is a positive number, it should be the first resource to tap into in case of an “emergency” – this way, the impact of said “emergency” on your less-liquid savings is minimized. But cash flow can’t always cover the random and not-so-random expenses that crop up. Enter the credit card. With only a modicum of planning and (if you use it right) no cost to you, you can defer expenses for a month. This intertemporal substitution allows you, the credit card user, to tap into not one but two months’ worth of cash flow (perhaps even longer, depending on how your credit card payment schedule aligns with your income). Voila:you are leveraging your cash flow! (Of course, it’s easy to see how such simple substitution can all go to pot in the hands of a foolish user.)

Let’s talk some numbers. After accounting for all fixed and budgeted variable expenses, including RRSP and RESP contributions, we currently have a monthly cash flow of about $1,100. In “cheap” months, almost all of that money gets dumped into our “mortgage pre-payment” fund. In “expensive” months, that money is used to pay for the pressure point, whether it’s as worthy as a car repair or as YOLO as a vacation. It is only on rare occasions that we actually dip into our non-RRSP savings. Buying our next (used) car will likely be one of those exceptions, for example. (And it’s a good thing, because we’ve been busily working toward maxing out our Tax Free Savings Accounts stuffed with extremely low-MER index funds!)

December and January were perfect examples of “expensive” months in our household. December is one of our extra-mortgage-payment months (along with July) because of our accelerated bimonthly payment schedule. This means we have to cough up an additional $1,200, and right after Christmas no less. This December, we also booked our airline tickets for an upcoming vacation to Vancouver – another $450 (discounted by the redemption of credit card rewards). We also spent around $400 or so on presents for family and friends. This month, our car is going in for repairs that we expect will cost around $1,000. Ouch. There are a couple family birthdays to prepare for, too. As you can see, our actual expenses exceeded our cash flow by quite a bit in both months. However, by using our credit cards judiciously, we won’t have to touch our savings:

• Our December net cash flow covered almost all of our extra mortgage payment (with the remainder covered by checking our couch for loose change. Nah, it was our chequing account float.);
• Our January net cash flow will cover the airline tickets, Christmas presents, and January birthday presents; and
• Our February net cash flow will cover the car repairs.