NerdWallet's Smart Money Podcast - Crypto-Earning Credit Cards, and Short-Term Investing

Episode Date: June 7, 2021

Credit cards are hopping aboard the crypto hype train, with some offering rewards in cryptocurrency. Sean, Liz and Sara discuss what they are and their risks. Then Sean and Liz answer a listener’s question about how to approach short-term investing. Also, please take a few seconds to fill out our two-question survey: http://bit.ly/nerdwallet-podcast-survey To send the Nerds your money questions, call or text the Nerd hotline at 901-730-6373 or email [e-mail].

Welcome to the NerdWallet Smart Money Podcast, where we answer your personal finance questions and help you feel a little smarter about what you do with your money. I'm Liz Weston. And I'm Sean Piles. To contact the nerds, call or text us on the nerd hotline at 901-730-6373. That's 901-730-NERD or email us at podcast at nerdwallet.com. Hit that subscribe button to get new episodes delivered to your devices every Monday. And if you like what you hear, please leave us a review. Also, we want to know what you want to hear about when it comes to money. There's a link in the episode description to an incredibly brief two question survey where you can weigh in. We'd love

to hear what you think. On this episode of the podcast, we're answering a listener's question about how to approach short term investing. But first, we're going to have a chat with credit cards nerd and occasional co-host of the podcast, Sarah Rathner, about crypto earning credit cards, which are credit cards that offer rewards in digital currencies. With the quick caveat that crypto is volatile and risky and that we are not investment advisors. Sarah, what do you think people should know about credit cards entering the crypto space? Yeah, it seems lately, I hate this phrase because I love cats, but you can't swing a dead cat without somebody talking about cryptocurrency. Many of us have either dabbled in it ourselves, or we have friends or family members who are investing in crypto. And

from my experience, nothing increases your risk of talking about crypto all the time, like investing in it. Yes, that's a hazard. Something that we're seeing here at NerdWallet on the credit cards team, which I'm a part of, is an increase in credit cards that are offering cryptocurrency rewards in some way. So you might see that as a cashback card that allows you to redeem rewards for cryptocurrency in addition to other ways to redeem rewards. Or you might see cards that are created by cryptocurrency companies that create accounts that allow you to trade crypto. They are also creating credit cards that earn rewards on different types of spending, and then you can deposit your rewards into your account and then buy cryptocurrency with those rewards. And so this is very different. This is something that's new.

And for people who might be looking to dabble in a very small way in cryptocurrency, these types of credit card products might be interesting to them. There's also mutual funds and exchange traded funds that invest in cryptocurrency. So it's a little more diversified. And in any case, we should also mention that cryptocurrency is not regulated. And probably when you hear about cryptocurrency, it's when it's gone up, but it's very risky. It's very volatile. You can lose a lot of money here too. And if you're only hearing the upside, you might think, oh, this is a great way to become a billionaire. Maybe not so much. Right. And there have been security breaches on cryptocurrency exchanges. So that's a risk too. Anytime anything is hacked, it's a risk to your finances. And when your credit

card gets hacked, you can get that money back. When you lose your crypto in this way, you don't really have the same insurance policy. And so like there are things that make it less secure as an asset. And that's just all things to keep in mind when you invest. And that's why our take on it here at NerdWallet is if you're interested in investing in it, great, but maybe don't load your portfolio with it. Maybe invest no more than 10% of your portfolio in things like cryptocurrency or other risky assets. And that's just a way to protect yourself. It's kind of like super micro-investing because if you've ever had a cashback credit card

that earns 1% to 2% on all of your purchases, you know how long it can take you to rack up maybe $25 worth of rewards. That could be, depending on how you use your card, at least one billing cycle, if not more, if you've made a major purchase. If you just kind of use your card casually, it might take a couple of months. So you're not talking about investing large sums of money of earned rewards on any of these credit cards. Right. And at this point, you can't take your crypto and walk into Target

and directly buy anything. No. So these sorts of things are changing. We're starting to see specific vendors, specific merchants allow payment in the form of cryptocurrency. I think the Oakland A's is accepting crypto for payments for one specific game. You can pay with Dogecoin. Oh, yeah. Yeah, I heard that. And also Microsoft's been accepting cryptocurrency for a while. There are some big companies that are doing it. Yeah. And then there's a resort in Las Vegas that partnered with Gemini, which is a cryptocurrency exchange. You can use specific cryptocurrencies to make payments there in their casino it's like gambling on top of investing in a way which i do yeah so now what does it mean like you know should i use my

cryptocurrency to buy baseball tickets and uh go to a casino now here's the issue with that um if the value of your cryptocurrency would go up in the future and you blow 100 Dogecoin or whatever amount on baseball tickets, then you've just missed out on the opportunity to hold on to your investment and allow it to grow over time. So there's a risk there. There's an opportunity cost. And it's kind of like, you know, what are you investing for? Are you investing so you have some crypto set aside to make these types of purchases? Or are you investing because you're hoping it grows? Yeah. So people need to understand what they're doing, understand what the particular crypto is that they're investing in and understand what their goal is, right? And we joke, but there is something to be said for understanding what you invest your money in.

Yes, that's kind of important. You know, a lot of people buy into hype, you got to do this, you got to do this with your money, you got to get this thing. And if you don't quite know what it is you're putting your money into, you don't quite know when you're doing well and when you're not. And then what next steps you might want to take based on how you're doing and how you're feeling and how the market is. So that's sort of what I would caution against. So obviously, you know, if you're going to invest in cryptocurrency, you should kind of get a sense of what it is, and how investing works. And like any investment, understand the tax ramifications

of selling cryptocurrency, because you don't want to end up with a giant surprise tax bill because you sold off a bunch of shares because you're like a crypto millionaire now. And then suddenly you owe. I mean, I've heard stories of people owing five figures to the IRS and not really knowing that that's what was going to happen. And it's also important to keep in mind the extreme volatility of crypto. We've seen a number of cryptocurrencies take a tumble in recent weeks. Bitcoin was down 30% over a single week recently. Dogecoin, my pet crypto, if you will humor a bad pun, was down by more than half. But by the time this episode is published, you know, these cryptos could have taken another tumble or totally recovered or totally skyrocketed.

Their trajectories are just so, so unpredictable. But I would venture a bet that those on the Dogecoin hype train are hoping that Elon Musk does not make another appearance on SNL anytime soon. And full disclosure, I have purchased Doge, as I've mentioned in the past, but that doesn't mean I think it's a good idea. I bought this as a joke. It goes to show you again how risky this can be because really the thoughts and opinions and public statements of just a few people in power whose opinions are listened to can dramatically swing the price of this asset.

And so that's another thing to think about because it's not based on anything tangible in the market like a good or a service or supply or competitive advantage over other brands or other things that you can measure. It's based on somebody's opinion, what they say on Twitter. Okay, well, I think with that, let's get on to this week's money question. This episode's money question comes from an anonymous listener who emailed us asking ETFs or index funds, which of the above is better for short term investing?

To help us answer this question, on this episode of the podcast, we are joined once again by investing nerd Chris Davis. Hey, Chris, welcome back to the pod. Hey, Sean, thanks for having me. Always good to be here. So our listener is interested in short term investing and is currently considering two options, ETFs and index funds. So let's start by explaining what each of these options is. So let's start with index funds. Index funds basically pull money from lots of investors into one big pot, and then the index fund manager invests these in various securities. So if it's a bond index fund, then these will be invested in bonds. If it's a stock index fund,

it'll be invested in stocks. What's really important to understand about index funds is that they're going to track an index. That's where they get their name from. And so what does that mean? Let's use the S&P 500 as an example. The S&P 500 is an index. And if you invest in an S&P 500 index fund, you're investing in all of the companies that make up the S&P 500. Your investment is distributed across all those companies in the same way that they are weighted in the S&P 500 index. So they're basically mimicking a benchmark, a market benchmark of some kind. And what's the advantage of that? So with that, you're getting really immediate diversification and it's really easy to establish. Rather than

investing individually in 500 companies, in this case, you're investing in one index fund that spreads that investment across all of those companies. Diversification is just incredibly important for long-term portfolios and lowering your risk and your volatility. But there are actively managed mutual funds and index funds are different, right? An index fund is going to be what we would call passively managed, meaning you don't have a fund manager back there picking and choosing and buying and selling stocks within the fund. It's passively managed. It just tracks that underlying index. An active fund, on the other hand, it's more hands on for that fund manager and they are picking, choosing, buying, selling stocks.

And that can actually lead to higher expense ratios. A passive investing strategy through index funds can really keep your costs down. And what do you think about these as an option for short term investing? It's generally not used for short term investing. Index funds are really good for long term investing because of the things we've talked about. They're low cost. They offer really great diversification. You're not going to be seeing someone buying and selling index funds on a short term basis. Well, one of the difficulties is that you can basically only buy them once a day, right? That's right. You can only buy them once a day at a fixed price that's established at the end of the trading day. And that's actually one of the biggest differences

between index funds and ETFs. Let's dive into that. Can you explain ETFs? Sure. So first of all, they are very similar to index funds. ETF stands for exchange traded fund. And like index funds, they pool investors money to buy various securities. They also often track an underlying index, just like an index fund. There are actively managed ETFs. They'll tend to have higher expense ratios. They'll be slightly more expensive to own where a manager is actively buying and selling them. But often you'll find ETFs are these passively managed, low cost investment vehicles, much like index funds. Okay. So these seem a little bit similar to each other. Can you break out how they're distinct?

Yeah. So the biggest difference between ETFs and index funds is that ETFs can be traded throughout the day, much like stocks, hence their name, exchange traded funds. You should remember index funds can only be bought and sold at the end of the day for a set price called the NAV, the net asset value. Whereas ETFs, you can buy and sell them throughout the day. If you watch their ticker, their price is going to go up and down just like a stock. And this can make it a lot more convenient to buy into ETFs than index funds. From what I understand, there are some tax differences between the two, right? It might not be a huge difference for the average investor. It's the way that they're structured.

Index funds are slightly more complicated in their way, and that can lead to additional capital gains taxes. It's not a huge difference, but you could say that ETFs are slightly more tax friendly than index funds. And also mutual funds can have a minimum, which can be a barrier to people who are just starting out. I would say that's another major difference. Index funds, often you're going to see a minimum. So that could be a couple hundred dollars. It could be a couple thousand dollars. And that can be a barrier to some people. Whereas ETFs, you buy in at the cost of one share and you can, of course, buy more than one share. But it tends to be easier for people to buy into ETFs because of that. You don't have

those high minimum investments. And both can be accessed through a brokerage account. Yep. Through most brokerages, you'll be able to sort through index funds and ETFs. So if you're looking for how much does this index fund cost to buy into, look for the NAV, the net asset value. That's going to give you the price versus the NAV, the net asset value. That's going to give you the price versus the ETF. You're going to see the price fluctuating just like a stock there. So as it relates to our listeners question, it seems like neither is really a great option for short-term investing. That's true. Both of them are very well suited for long-term investing. They have really low expense ratios. They're really easy to add diversification to

your portfolio. And this really makes them good for long-term investing, not necessarily short-term investing. When we're talking about long-term investing, we're thinking these are people's retirement accounts. It's 10, 20, maybe even 30 years. This is a really long time horizon. When we're talking about short-term investing, to be clear, we're not talking about day trading here. We're also not even talking about buying a stock and selling it a couple of days later. That's not necessarily investing. That's more the lines of speculating. And speculating is equivalent to gambling, whereas investing is putting some money in. You are putting it at risk, but you have a reasonable expectation of a good return, right? Right. You'll take a calculated risk based on

your timeline and the portfolio that you set up. So what kind of time horizon are we talking about when we're talking about short-term investing? Generally, we're going to look at, we'll say, five years. You really want to give yourself time to really ride out any market volatility that may happen. You put your money into an investment. It's possible that you could see steady gains for three or four years. And that last year, it really tanks. When you're investing for the short term, you really need to consider that volatility. Giving yourself about five years means that you might be able to ride through any of that volatility that does occur. The last thing you want is to need that cash right when the market tanks, and you can't let it stay in the market to try to recover

some of that value. So you really want to think in terms of making some short-term investments. So it seems like it's generally a smart idea when you have a shorter timeline to take on less risk so that you don't have to worry about so much volatility. Right. So if we look at it in terms of long-term investing, you have that time to ride out whatever may happen in the market. If there's a big dip, you can leave your money invested for another year, another two years, another five years. It's just, it gives you that flexibility to not be forced to sell when the market is down.

So then we take that and we look at short-term investing. That means you're gonna want to take on less risk. And whether that's by lowering your volatility, by investing in less risky, less volatile investments, or it's just taking on a virtually zero risk type of investment, there are options to do that. But you really want to think about that in short term investments. Let's talk about some of the options if you don't have five years, if your time horizon is shorter, if your goal is going to be one, two, three years in the future.

So you have a couple options here. And the whole goal is to really lower and minimize that risk. If you're talking about a couple of years here. One that's gotten really popular in recent years is the cash management account. And this is a really flexible account. Some of your funds can be invested. It can be used as a checking account and you can have a debit card attached to it. And they'll also earn generally higher interest rates than your typical savings account. We should mention that nothing's earning a great interest rate right now, though, right? That is true. What about money market funds?

Money market funds are really cool. It's a type of mutual fund that's actually going to invest in instead of stocks or one type of security. It will spread your money across very safe short term investments that those are things like U.S. treasuries. It could be high grade corporate debt. It's these investments that are very low risk, generally lower return. But it can also be a good way to see higher interest rates than your typical savings account. And then there's bank options, right?

Like certificates of deposit, savings accounts, high yield savings account, things like that. Yeah, you have your high yield savings accounts. Often you'll see these online these days, and those have some higher rates than your typical brick and mortar banks. But then you have other products like, yeah, certificates of deposit or CDs. With these, you'll put your money up to the bank for a specific amount of time. And in return, you'll get a fixed rate of return. I also want to talk about an option that people might be interested in, but it's a little bit

riskier for those who want to invest and get their money back within three to five years. And these are peer-to-peer loans. Chris, can you explain how these work and why they might be a little riskier? So with peer-to-peer loans, you are acting like the bank. You are the lender and you're giving it to someone who needs the loan. You can choose your level of risk. And that will also lead to, you know, if you choose something that's lower risk, you're likely going to see a lower return. We should talk about the diversification because that applies here too. You're not just investing in one loan. You're actually investing in a pool of loans, right? So that's a good way to think of it. Your money is spread out across various loans. So it's not just fixed on one recipient of the loan. You're actually investing in a pool of loans, right? So that's a good way to think of it. Your money is spread out across various loans. So it's not just fixed on one recipient of the loan.

And so all the risk is tied up in this one person, this one institution. It's spread out across. So again, you're diversifying your investment to lower that risk. Well, Chris, thank you so much for talking with us. I appreciate your insights. Yeah, absolutely. Thanks for having me. And with that, let's get on to our takeaway tips and I can kick us off. First up, know your long-term investment options. ETFs and index funds are both great long-term vehicles due to their low cost and easy diversification, but ETFs may be more accessible and convenient. Next, be careful with short-term investing. If you want to go this route, it's safest to go for options that have lower risk and volatility, which likely means accepting a lower potential return. And lastly, compare your short-term

investment options. Cash management accounts, money market funds, and certificates of deposit will have higher returns than a savings account and can be lower risk than other investment options. And that is all we have for this episode. Do you have a money question of your own? Turn to the Nerds and call or text us your questions at 901-730-6373. That's 901-730-NERD. And here's our brief disclaimer thoughtfully crafted by NerdWallet's legal team. Your questions are answered by knowledgeable and talented finance writers, but we are not financial or investment advisors. This nerdy info is provided for general educational and entertainment purposes and may not apply to your specific circumstances.

And with that said, until next time, turn to the nerds.