Warren Buffett is a vocal critic of credit card debt. At a recent Berkshire Hathaway meeting, Buffett told the story of how an acquaintance who had inherited some money asked him for the best ways to put it to work. The person had a significant amount of credit card debt at roughly 18% interest, and Buffett strongly suggested that the best use of the money would be to pay off the debt, and not invest. As Buffett put it, a guaranteed 18% return is "going to be way better than any investment idea I've got."
He's right. The stock market as a whole has historically produced annualized returns of about 10% over long periods, and most of the best investors can't do much better than 12% or so on a long-term basis. So, if you're investing with these kinds of returns while simultaneously paying 18% or more on credit cards (the average credit card APR has increased to about 24% from 18% since Buffett's comment), you're setting yourself up to lose money, mathematically speaking.
One reason Warren Buffett likes credit cards
This isn't to say that Buffett is completely opposed to credit cards. In fact, he's probably benefited significantly from credit cards over the years.
It isn't from using credit cards. Buffett has said that he pays for 98% of his own purchases in cash.
Instead, Buffett has made tons of money by investing in credit card issuers over the years. American Express -- of which Berkshire Hathaway owns more than 20% -- is one of Buffett's largest and most successful investments ever. Berkshire (through Buffett) has also invested heavily in Bank of America, which is the conglomerate's second-largest investment. In addition, Berkshire has substantial investments in Ally Financial, Citigroup, and Capital One, as well as in both major credit card processing networks Visa and Mastercard.
Between all of these, Buffett has made billions from companies that issue and profit from credit cards. Buffett originally paid $1.3 billion for Berkshire's American Express stake, which is worth about $22.7 billion as of this writing.
The point is that when consumers carry over $1 trillion in credit card debt (as they do right now), the only big winners are the banks.
Is Buffett right that consumers should avoid credit cards?
To clarify, Buffett isn't necessarily opposed to credit cards in all situations. He's opposed to carrying a balance and paying interest. If you put a restaurant meal on a credit card and pay it off before the balance comes due, there's little difference between doing that and paying cash. In fact, if you have a rewards credit card and pay your bill in full every month, you can actually make money by paying with plastic for everyday purchases.
However, the reality is that millions of people don't use credit cards this way. After all, credit card companies are out to make a profit -- not give things away -- and all of the reward and loyalty programs are designed to entice people to spend more money.
The bottom line is that credit cards can be an excellent financial tool when used responsibly. But they can be an absolute financial disaster if they aren't, so keep that in mind before you decide to play the credit card rewards game.
