In an earlier post, I recommended the PenFed cash-back credit card for people who spend a lot on gas. Well, PenFed just lost $2,300 of my money.

Shortly after receiving an email saying that my credit card statement was ready, I payed the balance of $2,300 in full. However, I had also signed up to their automatic bill pay service, which was scheduled to pay off the full balance from my checking account a week later. And it did, even though I had made the payment already manually, creating an overdraft fee on my checking account. Whether my own fault or not, I had now made two payments of $2,300, both showing up in my online PenFed account.

As soon as I noticed this, I called up PenFed and asked them to reverse the second transfer. There would have been a $20 fee to wire the money back to my bank, so I opted for a check instead.

A day later, the adjustment of $2,300 for the check showed up on my online credit card account (as it should). However, now the second payment of $2,300 no longer showed up in my list of transactions (highly irregular)! As a result, I’m missing $2,300, and my credit card balance still appears unpaid. Do I have to pay a third time?

When I called them about this, they couldn’t find proof of the second payment and asked me to fax them my checking account statement. They are currently working on it. More to follow.

Update: They sorted it out and credited my account with the missing money. It took 4 phone calls, lasting about one hour in total.

On a different note, they just sent me a letter saying that the PenFed Platinum Cash Rewards card will only pay 0.25% cash back on most purchases from now on, instead of 1% as before. This reduces its attractiveness, unless you only use it for gas purchases.

Cash back cards are much better than other types of reward cards for most people. Some cards give you reward points that you can then use to buy products from selected merchants, while others give you air miles. The former limits your use of your reward, while the value of air miles is slowly, but constantly inflated away by the airlines: every year, it takes more miles for the same flight, and it’s getting harder and harder to book a seat with miles alone. In addition, some miles expire: I lost more than 30,000 miles with United, and didn’t even get a warning.

As shown in my post about the best credit card, you need more than one card to get the most savings. Here are the best cards by purchase group. I used data from Mint.com to look at our largest expense categories, and identified the best card for each group. You won’t find any cards with rotating rewards categories in this list, since it’s cumbersome to remember which card to use when, and they mostly don’t give you good rewards in those categories where you really spend the most.

Best cash back cards by expense category

• Groceries: 6% cash back (AmEx Blue Cash Preferred, well worth the $75 annual fee, but check that your preferred supermarkets accept AmEx)
• Department stores: 3% cash back (AmEx Blue Cash Preferred)
• Everything else (including child care): 1.5-2% cash back, using the Fidelity Investment Rewards Visa card

To keep it simple, you could just use these two cards. We get over $1,000 in cash back per year from these two. If you are willing to carry more cards around, consider these:

• Restaurants and travel: 2% cash back with AmEx/Costco True Earnings card
• Gas: 5% cash back with PenFed Visa Platinum Cash Back card

Don’t apply for more than 2 cards in the same quarter, or your credit score will take a hit and your application might be declined.

All of these cards have no annual fee, except where stated (AmEx Blue Cash Preferred).

The PenFed Visa Platinum Cashback Rewards Card, which I’ve been using for years, pays 5% cash back on gas purchases, all the time. It takes 15 minutes to get the card, which is time well spent if you buy a lot of gas. Everyone can get it by joining the National Military Family Association for a one-time payment of $20 (no need to renew your annual membership) and opening an account at PenFed with just $5.

Dirtly little secret: No single credit card is best for you

These services get a referral fee from the card issuing bank, and would get a much lower or no commission if they told you that you are much better off by combining different cards. Each bank wants you to use their card exclusively. They may give you 1 or 2% cash back in selected categories, but hope to make money from you whenever you use the card to make purchases in a different category (or don’t pay your balance in full).

To avoid the “credit card tax” as much as possible, you should turn their business model on its head, and use the card that gives you the best rewards for each purchase. In fact, you can get nearly all the benefits with just 2 of the best cards.

Dirty little secret

Nearly everyone knows by now that borrowing through credit cards is very expensive. You can probably get a consumer loan from your bank at an interest rate of 10%, while using a credit card with a relatively low interest rate of 14% (Annual Percentage Rate) has an effective annual rate of nearly 15% [=(1+14%/12)^12 - 1]. A card with a 24% APR has an effective cost of 27%.

Because the credit card companies make so much money from consumers, they market their product aggressively, and offer you balance transfers with 0% interest for 6 or even 12 months, all the while hoping that you will maintain or even increase your credit card balance, and start paying high interest rates after the initial teaser period.

The high interest rates on credit card debt are thus a tax on desperation – or stupidity.

On the other hand, paying off your balance in full every month and getting a cash back credit card is actually good for you and reduces your credit card taxes.

Dirty little secret

As consumers, we’d be better off if no one ever used credit cards, because merchants could  reduce prices by up to 5% throughout, and competition would make sure that they did. The higher prices we pay is a tax on all of us.

Some people, however, pay lower taxes than others: those with very good or excellent credit scores often have cards that reward them  for each transaction. Therefore, credit card fees are really a tax on people who don’t get cash back: people with less than stellar credit or the uninformed. A research paper by the Federal Reserve Bank of Boston estimates that “On average, each cash-using household pays $149 to card-using households and each card-using household receives $1,133 from cash users every year.”

Each person thus faces a dilemma: everyone who qualifies is better off using reward cards, but collectively we all pay more as a result. Hopefully, new entrants such as Square will disrupt the cozy oligopoly in the credit card market and bring down fees significantly, or Congress will allow merchants to levy a surcharge for anyone paying by credit card.

The reason this works is that this strategy lets to benefit from volatility: the more the share price moves up and down, the better (lower) the average price that you get per share. Once I figure out how to run code on this site, I can give you a live example of dollar cost averaging in action.

For selling securities, there is no equivalent method to benefit from volatility. However, if you think of the investment life cycle as buying, monitoring and adjusting, and finally selling, there is an equivalent for the adjustment part, called rebalancing. Rebalancing means selling investments that are worth more than your target weight for that investment, and putting the money into assets that are worth less than their target weight.

Say you want to have 60% of your savings in stocks, and 40% in bonds. If you check your portfolio every year and find that both stocks and bonds make up 50% of your assets, you should sell bonds worth 10% of assets and invest that money in stocks, thus selling rather high priced assets and buying relatively low-priced ones without having to do any fundamental analysis. The same also works for individual securities.

Compound interest rocks

The take-away is that you should start saving early (in high school or college) to make best use of the power of compound interest.  In fact, the UK government gave GBP 250 to all newborn babies. The child trust fund, also called the “baby bond,” was mostly eliminated in 2010, when the country faced severe budget problems.

Deciding what type of mortgage to get and evaluating different rate and point combinations is complicated and far removed from our everyday lives.  That is why bad people who want to take advantage of you often do so in the realm of finance: selling you bad investments, inappropriate mortgages or oversized insurance. And we don’t have any natural defense against them.

The best advice I can give is to stay alert and not to trust anyone in finance. Also see my post Caveat Emptor.

• Stock brokers and commission-based financial advisers get a commission every time you trade based on their advice, leading to unnecessary turnover and high expenses in your portfolio. They may also recommend products such as mutual funds that are sponsored by their employer, rather than the one that is best suited to you.
• Insurance agents make more money the more insurance they sell you, whether it’s necessary or not.
• Real-estate agents have the worst conflict of interest if you are in the market to buy a home: not only do they want you to complete the transaction as fast as possible (to move on to the next client), but they actually benefit when you overpay for the house, since it increases their cut.

Therefore, take with a grain of salt what other people tell you about money, and ask yourself what they have to gain from a transaction.

Disclosure: I’m not working for any financial institutions, nor do I have a consulting contract or other contractual relationship with any financial institution or agent.