Credit Card Karate: The Moves to Block Spending

The following is a guest post from Marotta Wealth Management.

The availability of easy credit does not encourage financial virtue. Five minutes of credit card indiscretion literally can undo a life of financial responsibility, just like flirting at a bar with an available stranger can threaten marital fidelity.

You are trying to stick to your budget and live well within your means. You want to be a supersaver, someone who amasses real wealth by living simply and investing the remainder. To achieve these goals, you have to set rules in advance for how you will handle credit. If you don't, credit cards could undo all your hard work and planning.

A life of credit card debt is like the worst slavery imaginable. Failing to pay just a few hundred dollars a month will cause your debt to spiral out of control. At the end of just three years you could owe about $9,600, the average family's credit card debt.

Credit cards rates of 18% or even more are typical when you fail to pay. It used to be called usury and was illegal. But nowadays it is described as financial services and has become a highly respectable career.

If you don't stop buying that $200 worth of junk on credit, your debt will only worsen. After 24 years, you could be over a million dollars in debt for just $58,000 worth of merchandise. But if you switch that engine from reverse to forward, you could retire as a millionaire simply by saving and investing what you aren't paying on your credit card.

Consider the two sides to using credit. On the one hand, credit cards provide you with convenience, protection and help you maintain your budget. On the other hand, they can be a seductive siren's song leading you to financial ruin.

A few visualization techniques can help you avoid the wanton use of credit cards. Studies show that when people pay with a credit card, they are willing to spend twice as much money as when they use cash. Other research indicates that the biggest savings are enjoyed when people refuse to make small everyday unnecessary purchases. Put these two studies together, and by simply using a credit card you risk doubling your spending and cutting your savings in half. Thus credit card debt can sink families even faster than saving and investing can help them grow rich.

In the first visualization, imagine that everything you buy with a credit card costs twice as much as the number on the price tag. Only if an item costs twice as much will you be as hesitant to purchase it as if you had to pay cash.

To use the second technique, remove the decimal place on the price when you use your credit card. The younger you are, the more failing to save early will cost you when you retire. For example, at age 20, the $8.50 lunch you charge will cost you $850 in your retirement at age 63. If that isn't incentive enough, add another zero. It will cost you $8,500 in your retirement by age 85.

The years after college and before children are a great time in your life to save. You may not have another time to save aggressively until the kids graduate from college. You lose time and squander your resources if your credit card spending dampens aggressive savings. Every seven years you wait to fund your Roth IRA, you cut your retirement standard of living in half.

There's a greater advantage to contributing $2,000 annually for the seven years after college then beginning during the eight year and continuing for the rest of your life. With normal market returns, after seven years of $2,000 annual contributions, your investments will be appreciating at a rate of more than $2,000 a year, without any additional contributions.

Reining in your spending anytime is better than concluding that credit card debt is inevitable. Wait seven years from now and you cut your retirement lifestyle in half again. So visualize cutting your retirement in half or your credit card.

If you don't think you have any problems with your use of credit cards, but you haven't been saving and fully funding your 401(k) and Roth IRA, you do have a problem. If so, put the credit card back in your wallet and start saving.

Using a credit card properly is important. Not abusing a credit card is essential. Unless both partners in a marriage agree on how they handle credit, the cards aren't worth the plastic they are printed on. Either spouse should have veto power regarding the use of credit.

Each partner needs this respect because both parties can be liable for the underlying debt. So if you are part of a couple who are always paying fees or interest, you are better off running your budget with cash and envelopes.

There is no shame in alcoholism, only in being a drunk. Similarly, there is no shame in having credit troubles, only in continuing to be spendthrift. Financial troubles sink a great number of marriages, nearly all of them because they fail to admit that for them an open credit line is an empty credit line. Alcoholics struggle similarly with an open bottle.

Thus the only shame around credit problems is an unwillingness to accept help. Many people use credit cards intelligently for nondiscretionary purchases such as bills, utilities, groceries and gasoline. But smaller impulse items, such as eating out or spending on books, music, electronics or clothes, can quickly wreak havoc on their spending plans.

If one type of purchase causes you trouble, stop using credit cards in that area. If one person has difficulty, the other should be willing to bear the burden of paying the bills. Cash accounting means you can't spend too much. It is the perfect exercise of sobriety for your spending habits.

One of my favorite movies is "The Karate Kid" starring Pat Morita as Mr. Miyagi. Miyagi trains his young apprentice Daniel by having him wax his cars, sand his floors and paint a fence. Only after several days of backbreaking work does Daniel realize that his body has learned the defensive moves of karate through the muscle memory of "Wax on, wax off."

You can't learn the critical lessons of finance with the electric waxing machine of plastic credit. By refusing to use credit, you have the visual feedback of money going from your paycheck to a budget envelope and then leaving your wallet in exchange for something you really need.

Most people don't learn these lessons from their parents. And even if your elders handled money well, you still have to learn the lessons for yourself. Having a parent who excels in karate doesn't mean you can crane kick.

So if your spouse vetoes the use of credit, you can either get mad like Daniel did at Mr. Miyagi or you can get busy learning financial karate.

Comments

[Bob]

I am not sure there was a way to fit any more crazy assumptions into one piece.

"Studies show that when people pay with a credit card, they are willing to spend twice as much money as when they use cash." - I would like to see these studies

"If you don't stop buying that $200 worth of junk on credit, your debt will only worsen. After 24 years, you could be over a million dollars in debt for just $58,000 worth of merchandise. But if you switch that engine from reverse to forward, you could retire as a millionaire simply by saving and investing what you aren't paying on your credit card." - Well, this would require a card with 18% interest, making no monthly payment, and some company making your credit limit over $1 Million dollars in spite of the fact that you never pay them.

"If you don't think you have any problems with your use of credit cards, but you haven't been saving and fully funding your 401(k) and Roth IRA, you do have a problem. If so, put the credit card back in your wallet and start saving." - So, regardless of my salary or spending patterns, if I don't have ~ 20K laying around to invest each year its because I use a credit card?

FMF, you do yourself a disservice associating with a post like this.

[Michael Gardner]

"On the one hand, credit cards provide you with convenience, protection and help you maintain your budget."

So do debit cards when you live on less than you make and have an emergency fund.

In response to the previous poster, both McDonalds and Harvard did studies showing that people who use credit cards spend on average approximately 18% more. I know that's not double, but it is significant.

Besides, by not having credit cards, I know what's in my wallet--CASH!!!

[Old Limey]

From what I have gleaned from postings by other readers on this site, most are already very well aware that the intelligent usage of credit cards require that you exert discipline over your purchases. They also realize that when you pay off your balance in full every month the card company is still making money off the merchants but it's minimal compared with what they extort from many in late charges and interest.

Credit cards are a wonderful convenience if you have discipline and can be poison if you lack discipline.

[Eric]

Nothing like a Marotta post to stir up some comments hehe! I miss these. I like talking about credit cards because I believe it informs people rather than make them blindly anti-credit.

[FMF]

Bob --

I post a wide variety of articles with many different opinions. The pieces I write myself are my opinions, what I do, etc., but guest posts are their opinions, thoughts, and so on. And what they say may or may not be in agreement with my POV. But I think there is value in hearing other's thoughts and that's why I post them (FYI, I also note that it's a guest post at the start of the piece so people know it's not me writing.)

Regarding the "spend more with credit cards" part, there have been many studies that seem to indicate that people do spend more when they use a credit card than they do when they use cash (or similar notions). A few I just Googled:

http://www.daveramsey.com/the_truth_about/credit_card_debt_3478.html.cfm

http://www.getrichslowly.org/blog/2008/09/23/research-reveals-credit-cards-encourage-spending/

http://www.livescience.com/culture/080907-cash-credit.html

It's a debated topic to be sure, but I just wanted to be clear that the author of this piece didn't the thinking out of thin air.

As for my personal beliefs, I use a credit card and have for years. I get lots of cash back, have never had an extra fee, and don't think I spend more using it. Then again, maybe I'm deceiving myself on the last point. ;-)

[kitty]

@Bob "Studies show that when people pay with a credit card, they are willing to spend twice as much money as when they use cash." - I would like to see these studies"
Me too.

@Michael Gardner, FMF: "In response to the previous poster, both McDonalds and Harvard did studies showing that people who use credit cards spend on average approximately 18% more. I know that's not double, but it is significant."
1. 18% more is not the same as "twice as much". 2. "on average" doesn't mean "every single person. If you take 2 people and one spends 40% more and another one spends the same, you'll get 20% on average. People who cite those studies often translate "on average" to "everyone". 3. None of these studies was what is known as "gold standard" of studies - i.e. randomized control study involved a large number of people. Or even population study - the second best. Most of these studies used models which is not a very reliable method. They also were too small to be conclusive - I actually took a look at some of them. Often these studies involved a very specific subgroup - students, who aren't exactly the most mature part of the society. More importantly, none of the studies correlated spending with payment pattern i.e. none of the studies looked specifically at people who pay their balances in full.

One doesn't really need a study to know that most of the people who carry balances spend more than they would've with cash; otherwise, they wouldn't have carried a balance. The reason I said "most" is that I excepted people with medical emergencies or those who do credit card arbitrage. But the vast majority of those who carry balances certainly spend more; otherwise, they would've just paid the bill. So, if you take a group of 10 people, 6 of which carry balances and 4 don't and compare it with a group of 10 people who don't use cards, you'll certainly get more spending in the first group. Everyone is with me here? But this doesn't say anything at all about the remaining 4 people, not unless you look at these studies in detail and checked the distribution. Anybody did it? I doubt it.

Finally, why do people who haven't even had a basic statistic course in college feel like they are qualified to interpret and cite statistical studies?

@Tamara Holmes - if you want to find more customers for whatever you are selling, financial blogs are probably not the best place. I'd imagine most readers/posters here are more careful with money than an average American and are less likely to need your services.

@Old Limey - "Credit cards are a wonderful convenience if you have discipline and can be poison if you lack discipline."
Totally agree.

[FMF]

Kitty --

I think that post by Tamara was spam. I eliminated it.

As far as "Finally, why do people who haven't even had a basic statistic course in college feel like they are qualified to interpret and cite statistical studies?" goes, not sure who you're talking to -- me, Michael, or the original poster.

[Ryan K]

More evidence that people paying in plastic are willing to spend more also comes from the post on Now Even God Takes Credit Cards:

6. Salvation Army kettles -- In 2008, Salvation Army chapters in El Paso County, Colo., Dallas-Fort Worth and Plano, Texas, became the first in the United States to provide bell ringers with credit card kettles. "The number of contributions made was relatively small," says a spokesman, Maj. George Hood, "but the bright side was that the average gift was higher, between $15 and $20." More markets will be tested in 2009.

[Britt @ Your Roth IRA]

Excellent post. "In Rich Dad, Poor Dad," Robert Kiyosaki notes that assets put money in your pocket, while liabilities take money out of your pocket. If you want to be rich, just buy assets instead of liabilities.

It's the same with credit card debt (liability). Why collect interest on your debt when you can collect interest on your investments (assets)? Instead of paying the credit card companies every month, live below your means and pay yourself by investing, then you get to collect the interest which you can then reinvest. As a result, you throw the whole cycle in reverse and end your life with wealth instead of debt!

[[email protected]]

I thought your post was great, full of interesting statistics that help motivate readers.

I disagree with Bob, I live a frugal lifestyle (in February 2010, I'll be debt free) and plan my finances with spreadsheets and determination. I believe I can accomplish becoming a millionaire by the time I retire by being frugal and clever, especially with the use of tax deferred plans like 401(k)s and using a Roth IRA.

That said, I use credit cards as a tool, they make me free money via the reward programs. The trick is to make sure you control your spending with them so you can pay them off each month. Carrying a balance is the ultimate evil in credit card world.

Thanks for digging for the stats too! I don't think I've never heard the decimal place move piece before... It's always nice to learn something new :)

[kitty]

"As far as "Finally, why do people who haven't even had a basic statistic course in college feel like they are qualified to interpret and cite statistical studies?" goes, not sure who you're talking to -- me, Michael, or the original poster."

Mostly to Michael, but in reality to everyone who doesn't seem to understand that "people spend more on average" is not the same as "everyone spends more" and who doesn't have enough of logical thinking/math knowledge to realize how those people who carry balances affect these averages.

Maybe I should've reworded it "people who either don't understand statistics or people who don't bother to actually read the studies and find out their limitations and what they showed or didn't show"...

[Robin Smith]

Follow these simple tips to get the most from your card.
Tips:-

Pay your credit card bills on time. This is the single most important thing you can do to preserve and enhance your credit rating. Always pay at least your minimum payment and allow time for your payment to reach the company if you are using the mail.

If possible, pay off your balance in full each month. If this is not possible, then make as large a payment as you can comfortably afford. Paying off or paying down your balance is a sound financial move—one that will save you money on interest charges.

If you can’t pay off your balance in full, then slow down on your credit card use for the next while. Take time to step back and have a careful look at how much you earn and how much you spend each month. A little budgeting can save you big money down the road.

[Tamara Holmes]

The key piece of solving your debt crisis is to ensure you do not discount the condition completely. You must analyze the problem and resolve how to answer it. Talking to people with economic knowledge (be it family, a close friend, or even employees at the concerned credit card company), can bring about viable solutions. Timing is of the essence, so you must be fastidious; nevertheless taking the necessary steps to negotiate a settlement can sometimes be the advantageous decision.