A reward checking account is a checking account that pays a high interest rate up to a balance cap but requires you to use its debit card X number of times a month among some other easy-to-meet requirements.
For instance the account I recently opened with a credit union pays 3% interest on balance up to $20,000. It requires 15 debit card charges in every calendar month. Otherwise the rate falls to a negligible level. The other requirements are easy to meet:
- direct deposit: you schedule a recurring ACH transfer from your main checking account
- e-statements: you opt out of paper statement when you set up the account
It’s a perfect setup for an emergency fund. Most of the time the $20k just sits there, earning 3%, higher than the yield on intermediate-term bonds these days, with no risk to principal.
The debit card from the reward checking account just became my lunch card. I buy lunch from the cafeteria at work every day. It’s very easy to use it 15 times a month. Once you develop a rhythm, you don’t really need to count.
My average meal costs $6. If I use a credit card that gives me 2% rebate, I would only get $6 * 22 weekdays in a month * 12 months in a year * 2% = $32 in credit card reward in a year. Meanwhile, my $20k in the reward checking account earns $20,000 * 3% = $600 a year in interest instead of a typical $20,000 * 0.85% = $170 a year if I just leave the $20k in an online savings account.
Extra $430 in interest versus $32 in credit card reward makes using the debit card a no-brainer even though the interest is taxable and the credit card reward is not. I just transfer in $200 a month, spend $130 or so on lunches, and let the $20k sit idle earning 3%. If it bothers me that I have $70 extra left over every month earning nearly nothing, I can transfer it out once in a while.
You can look for reward checking accounts at depositaccounts.com. Consider both the rate and the balance cap. An account that pays 4% but caps the 4% to only $10k isn’t as good as one that pays 3% on up to $20k. I made this simple spreadsheet for you to compare different options: which reward checking account?
Opening a new account takes a little bit of time, but it’s a one-time effort. Once it’s set up, it goes on autopilot. My reward checking account pays $430 in extra interest each and every year versus leaving the money in an online savings account. It’s a very good return on a one-time effort.
Our hypothetical couple in the "double the bond yield" pursuit decided to put $20k in a reward checking account. Remember their goal was to double what they earn from bonds in a $1 million portfolio (40% invested in fixed income) without taking any more risks.
Even though the yield on the benchmark Vanguard Total Bond Market Index Fund rose from 1.7% to 2.1% since they started their pursuit, having $20k earn 3% with no risk to principal still beats earning 2.1% with risk to principal. For instance the bond fund is down 2% so far this year versus up 2% if they had $20k in a reward checking account.
Going forward, they expect to earn extra $20k * (3% – 2.1%) = $180 a year by having the reward checking account versus investing the money in a bond fund.
This final move pushed them over the goal line! When they started the journey a year ago, they wanted to earn extra $3,400 a year for each person. Little by little, they moved toward the goal. Now they finally did it.
[Photo credit: Flickr user gibsonsgolfer]