Wiser Financial Advisor – Managing Credit Card Debt 2
Hi, Everyone. Welcome to the Wiser Financial Advisor with Josh Nelson, where we get real, we get honest, and we get clear about the financial world and your money.
This is Josh Nelson, Certified Financial Planner and founder and CEO of Keystone Financial Services. We love feedback and we’d love it if you would pass it on to me directly: email@example.com . Also please stay plugged in with us, get updates on episodes and help us promote the podcast. You can subscribe to us at Apple Podcasts, Spotify or your favorite podcast service.
Let the financial fun begin!
Today we’re going to talk about managing credit card debt, which is a hot topic in the financial world these days. Before we get there, I’m going to pause for a second and talk about why the Wiser Financial Advisor exists. I started this podcast because I got into this business to help people. I’ve got the heart of a teacher, and the podcast is a way to help teach. On the podcast I can not only share what I know from my experience, but also share the wisdom collected from other sources over the years.
When you learn how to do anything, one way is of course trial and error. That’s the most expensive and time-consuming way to learn. Another way is to hire a coach or talk to somebody who could be a mentor—some who’s made all the mistakes, spent all the time and wasted all the money. We’ve seen it over and over because we’ve literally had thousands and thousands of conversations with people and we can see what works. We can also see some of the landmines that people have stepped on during their financial lives. We have a lot of collected wisdom that we’re able to share. So, the podcast exists to get and give wisdom. Acquiring wisdom is the wisest thing that anybody could pursue, and so that’s why we do the Wiser Financial Advisor.
Today we are going to talk about credit cards. I read in Barron’s this week that credit card interest rates are as high as they’ve been since Bill Clinton was president, and that’s going way back. You look at interest rates and where they are today, very, very high: about 18.1% average. That’s just the average credit card, which tells you a lot of credit cards are much higher than that.
I want to talk to you about credit card debt and how to manage it. I think average Americans use it as a way to budget. They use it as a way to get points and miles and so forth. In fact, I think most people think it’s weird if you don’t have a credit card and if that isn’t how you’re managing your money. But again, I have a lot of experience with people that have run into some tough times because of how they’ve managed credit card debt or because they’ve used credit cards at all.
Recognize that when you use a credit card, unless you pay it off immediately—and I know a few people who do this; believe it or not, they’ll spend money at Chick-fil-A and then go home and pay that off on their credit card right away. Most people don’t do that. The bank gives you an interest free loan for a few weeks or a month, whatever your credit card cycle is. The key is, they’re hoping that somewhere along the line you’re going to run into some financial trouble. You may have had very good intentions of paying off the full balance at the end of the month, which means you don’t have to pay any interest and you get to keep the points or the miles or whatever it is that they’re incentivizing you with.
Those of you who have been around for a while and have any kind of life, you know that if you’ve got a car or a house or a dog or kids or anything like that, unexpected things will come up all the time, things that you had not planned on, maybe things you couldn’t even have foreseen would be a possible expense you’d be incurring, surprise expenses.
You may have heard of Murphy’s Law, which says that if anything can go wrong, it will. And of course, Mr Murphy comes along an awful lot. Even if you’re really careful and plan ahead, stuff still happens that you cannot anticipate. So oftentimes, we end up sitting down with somebody who has a whole stack of credit cards with balances they’re unable to pay off. It might be the thing bought at Home Depot for 0% interest for six months or whatever, right? There are a multitude of different things out there now that offer a buy now, pay later arrangement. Amazon offers that, and all kinds of organizations want to do this now because they’re not stupid and they want to make money. A percentage of people will not be able to pay off that loan, will not be able to pay off that credit card balance. They’ll start paying interest, whether it’s 18%, 14%, or 20-something %. That’s ugly when you think about that much interest.
Credit card division is typically a very profitable division of the bank. They’re hoping that you’re going to be one of the people that ends up not being able to pay off whatever it was that you borrowed money for. You’re going to run into some tough times and now you are going to be paying that high rate. So if you’re using credit cards at all, you are playing with fire. You are competing against Mr Murphy and guessing that you’re not going to have major things happen that will prevent you from paying off that credit card balance.
Now, this is the point where I’ll get all kinds of people saying, “Wait, wait, wait. Josh, you’re crazy. The bank is giving you this interest free loan, you’re going to get the points, the miles, cash back, all this stuff. I’ve done it for years and I’ve never run into problems. I’ve never paid a fee, never paid interest.”
Good for you. That’s great. But I can tell you that for the average person, that’s not the experience. And that’s exactly why banks offer the points and the miles. Because they want to keep you using those instruments that are very profitable. When it comes to credit cards, know that what you’re doing is borrowing money. And there is a possibility—in fact, the odds are that there will come a time when you cannot pay that balance off. Then even if you just carry the balance for a month or two, the interest that you’re paying easily negates the points and miles or whatever it is that you’re getting.
Also, let’s assume that you’re one of the people carrying balances on different debts and you haven’t been able to pay them off. How to knock out debt and get it paid off quickly is particularly important right now because the economic situation that we have globally—not just in the US—is deteriorating. They say that we’re probably going to be in a recession if we’re not in one already. The debate right now isn’t if we’re going to have a recession, it’s actually more of how bad is it going to be and how long will it last.
Last year in 2021, the Federal Reserve talked about inflation being transitory and so they continued to keep interest rates very, very low. The federal funds rate was zero for a long, long time after COVID, much longer than it should have been. And now we’re paying the price for that with runaway inflation and high interest rates. So the circumstances that we’re going into are not very pleasant. You may get laid off, you may have other things that happen, like your stock market value going down. There are circumstances where people don’t quite feel as wealthy as they were before, or it might just be the impact of inflation starting to squeeze you. In such cases, you might feel more tempted to carry a credit card balance or buy something and not pay it off right away.
Our favorite way of eliminating debt of all types (aside from the mortgage, which is a different kind of debt, one you still want to pay off eventually but we’re going to put that in a different category because interest rates are much lower typically on mortgages and you’re also using it to buy an appreciating asset, an asset that should be going up over a long period of time). Every other kind of debt, whether it’s student loans or credit cards, car loans, truck loans, boat loans, whatever kind of loan you’ve got, we want to eliminate as quickly as possible. And when it comes to credit cards, those usually are the ones that we want to tackle first. They’re also the ones that are typically the lowest balances.
We like the debt snowball approach which is not ours, it’s Dave Ramsey’s, but in my experience going through a lot of conversations with people, the debt snowball approach is the way that people get stuff paid off the fastest—not with the least amount of interest necessarily, but the fastest. With the debt snowball, what we do is make a list of all of our debts from smallest to largest. You can take a piece of paper or you could do a spreadsheet or use budgeting software. There are all kinds of tools that you can use. The bottom line is to make sure that you’ve got a list of all your debts from smallest to largest. Don’t put them into categories; don’t group them together. If you’ve got five credit cards and they add up to $2500, list them individually in order of balance, smallest to largest.
The debt snowball approach eliminates payments and increases your cash flow as soon as possible, so now you’ve got some breathing room. The breathing room is necessary because if you are going to get these things paid off faster and snowball them, you need to start eliminating some payments and freeing up some of your budget. That means we take all of our extra money, every dollar that we can possibly come up with that isn’t necessary to buy our family’s food and so forth, and we put that money on the smallest debt. Chances are, it’s probably only going to be a month or two and that thing is going to be paid off. Let’s say that particular debt amounted to 20 or 50 dollars that we were required to make on the payment each month. Now we’ve got that extra 20 or 50 dollars that can be applied to the next debt on the next month around.
You’ll find that you’ll pay things off much faster and get down to zero debt ASAP. Those of you who have ever gone through Financial Peace University know that they go through this in detail as part of that program. We recommend that program for those of you who are trying to get your financial house in order. It’s a great educational program. They say it takes on average about a year and a half for people to eliminate all their debts except for the mortgage when doing the debt snowball. I’ve seen people do it, so I can tell you from experience that going through this process does work and people feel a sense of freedom.
I’ve had debts in the past. I’ve never carried a bunch of credit card debt, but certainly I’ve had car loans, a student loan way back when I got out of college. But I got stuff paid off quickly, and when you get stuff paid off, there’s just this sense of freedom. You walk a little bit lighter and have a sense of peace. That’s why they call it Financial Peace University, because as you get your stuff paid off and get money accumulated in the bank, you are much more prepared for the unexpected things that are going to be coming up.
And it might not be you that needs to hear this. It could actually be a friend or family member. Might be a coworker or somebody else that you care about that you’re sharing these conversations with, Certainly you can share this podcast episode with them as well.
Another thing we can do to prevent running into problems with credit card debt or avoid getting into credit card debt to begin with is having a cash reserve, an emergency fund. We recommend three to six months’ worth of living expenses for most people. I say most people, but you might be in a different situation where you need more cash than that, e.g. if you’re self-employed or in a sales type position where your income jumps all over the place. Maybe you own your own business, or maybe you’re in a situation where you think you might get laid off. Generally speaking, we want about three to six months’ worth of living expenses in savings or checking accounts.
Your emergency fund is not in the stock market, it’s not in the bond market, it’s not in cryptocurrency. It’s just sitting in the bank or credit union in your checking or savings account. Sometimes people say, “Well, can’t I put it in CD’s?” You could, but the chances are that when you have an emergency, it’s probably not going to coincide with when your CD matures. I recommend checking or savings that you just accumulate in a straight cash bucket for your emergency fund, your rainy day fund, whatever you want to call it. It’s basically your Murphy’s Law funds so that when bad stuff happens, unexpected stuff happens, you’ve got that cash sitting there.
The other thing I want to talk about is budgeting in general. I’ve been a financial advisor for 23 years now and I’ve had tens of thousands of conversations about this. I can tell you that the vast majority of people do not budget or have any idea what they’re actually spending. It doesn’t matter how much money they make, by the way. I’ve talked to people who make very little as far as income but have a very good budget. They know where their money is going. And I can tell you that some people making seven figures have no idea how much money they’re spending. So is isn’t a matter of income. It’s a matter of actually having the discipline to use software, use spreadsheets, use whatever you need to do to track and figure out how much you’re spending, and use that as your means of figuring out how much needs to go into your emergency fund.
If you’re at square 1 right now and not sure what you’re actually spending or where your money is going, sometimes that’s actually the problem. People sit down with me and say, “Well, I really have no idea where my money is going. I don’t know why I don’t have any extra money. I’m making X number of dollars. Between my spouse and I, we make a lot of money, but it doesn’t seem to go anywhere. It seems like we spend all of it. Not sure where that money is going.”
In that case, I would recommend you use some type of tool. You could go really draconian and cash your paychecks and use envelopes. Some people have to do that because they’ve had such a hard time managing money. They’ll go to a cash envelope system. That’s hard in today’s world, I’ll admit. So for most people, I do recommend you use some type of tool. At Ramsey Solutions they have a product called Every Dollar. It’s really important to know where your money is going because we work hard for our money and we don’t want to see it all go away.
We want to make sure that we’re building wealth with part of our income. We need to have enough margin for bad stuff that’s going to happen, bad stuff or unexpected stuff; we want to make sure that we leave plenty of margin toward that because that is part of life. You’re going to have unexpected expenses that come up and sometimes those can be quite large. You might be a responsible citizen and have all your insurance, your homeowners insurance, all those sorts of things but that stuff has deductibles, right? And there are certain things that aren’t covered by insurance. So it’s important to leave lots and lots of margin, lots and lots of distance between Mr Murphy and your own financial situation.
Credit cards are something to be really careful with. If you’re playing that game, you are playing with fire. Just recognize that the bank wins in the end. You don’t want to be one of those people that end up paying interest and fees. I know a lot of people that say, “Well, that would never be me.” I also know a lot of people that didn’t think it would ever be them and they ended up carrying balances. And remember, it doesn’t take that long. It only takes a month or two, and it could negate all the benefits of any points or miles or anything like that that you’ve been getting. One failsafe on this is just to use a debit card. Get rid of your credit cards. Use a debit card instead. It’s convenient, it takes the money right out of your checking account, and it guarantees that you will not accumulate debt because the money will run out and you won’t have any more in your account to spend. That’s a way to make sure that your budget doesn’t go too far and you’re not getting that over the tips of your skis.
Make sure that you are managing your budget responsibly. We talked about that and also making sure that you’ve got plenty of cash, plenty of insulation between yourself and any unfortunate things that would end up coming up in the future. Remember that emergency fund is not used to save up for your car or anything like that. You always want three to six months’ worth of living expenses sitting in cash in a checking or savings account. Yes, I know the interest is paltry. There’s hardly any interest on those accounts right now. It doesn’t matter. It’s something that’s not going to go up and down like the stock market or the bond market, the cryptocurrency market or real estate market. Pick any market and it’s going to go up and down. Having it in cash in an emergency fund for three to six months or more depending on your personal situation, is a great way to make sure that you’ve got plenty of insulation between you and Mr Murphy.
So that’s it for today. I hope that’s helpful. There are lots of great resources out there. If you know somebody who is struggling and needs some in-depth coaching and good foundational stuff, the Dave Ramsey resources are great. We are big, big fans of it and we provide the Every Dollar program for our employees and all team members at Keystone Financial Services. We believe in it that much. We eat our own cooking, right? We’re all using it ourselves. I also highly recommend Dave Ramsey’s book Total Money Makeover and Financial Peace University, all great ways for people to get started and get that foundation going.
If there’s anything we can do to help support you or your friends, your family, your coworkers, anybody that really could use some help, even just getting started, our job is really more on the wealth building side of things, so oftentimes we get involved with people once they’re past those initial stages of cash and paying off debt and so forth. But we are here for you, your friends, your family or coworkers.
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This episode has been prepared for informational purposes only and is not intended to provide and should not be relied upon for tax, legal, or accounting advice. You should consult your own tax legal and accounting advisors. Investment advisory services offered through Keystone Financial Services, an SEC registered investment advisor.