First some business…

As some of you may have noticed, I’m a delinquent (which I explained in my last post Why do I have to wait until I’m in trouble to clean up my finances?) And as a delinquent, I have neglected to tell you about some awesome finance blog round-ups that I have been featured in recently. So to atone for my sins, I have a list of great round-ups below.

(For those of you unaware of what a Blog Carnival or Round-up is, it’s when a bunch of bloggers submit posts to one blogger who then picks the  best and features them in one post)

• Carnival Of Personal Finance #324: The Universe Edition hosted by Christopher at StumbleForward.com
• Carnival Of Personal Finance #315 : Bring On The Long Weekends hosted by Canadian Personal Finance Blog

Now to the good stuff…Airline Miles Infographic

The team at Deals.com put together a pretty cool and highly informative infographic about Airline frequent flyer programs and their branded credit cards. If you are considering joining a mileage program or getting a branded credit card, then check out the image below.

Infographic from Deals.com

Recently, my wife and I had what I call a “Come to Jesus” moment. Basically, we had to face reality. We had let a number of areas in our finances slip. Mostly, we just got lazy. So we are currently putting everything back in order. But this experience has left me asking myself, “Why do I have to let things get bad before I shape up?”

Maybe you’ve found yourself in the same boat.

You are sticking to your budget and saving money. But then one expenditure comes up and you decide to dip into your emergency fund (even though it wasn’t an emergency). Then another thing comes up, and then another, and so on. Next thing you know, you are pulling our credit cards again.

Hopefully I’m not alone in this boat (let me know in the comments).

Long before making big, bad decisions, we started by just being lazy about little things. And rather than making changes when it was easy, we waited until things were hard. I’ve repeated this pattern a couple of times in my life.

• Step 1: Get everything in order.
• Step 2: Start slipping in small ways (usually dining out).
• Step 3: Start making bigger, badder decisions (and yes badder is a word).
• Step 4: Realize what I’ve done and work for months to fix it.
• Rinse and repeat.

The problem is that each cycle is costly. It sets us back and puts our goals that much further out of reach.

What’s scary is that our entire nation acts the same way.

We’ve been on a spending spree since the Obama Administration took office nearly three years ago. Although many people and groups warned of the dangers, Congress charged forward. Then, we were hit smack in the face with warnings of credit rating decreases, actual credit rating decreases, and the risk of default. We hit our credit limit. It was only at that point that Congress decided to make some effort to reduce spending.

The scary thing though is that fixing my financial mistakes is not that hard, it just takes a little time. Fixing the financial mistakes on such a large scale – the United States of America – will take decades and a lot of money out of everyone’s pocket. And don’t tell me that it won’t affect your because businesses and the rich should pay more. Businesses and rich people are what drive the economy. They put the money into the economy that gives all of us jobs. So if they have less to spend, then our economy slows and jobs go away.

So why do we as individuals and even huge governments let things get so far out of control before we wake up and have a “Come to Jesus” moment? Why don’t we guard ourselves against deviating from our course?

The government has no excuse.

Elected representatives should represent their constituents and the system of checks and balances should weed out stupidity. But it seems to have failed of late (for a lot of reasons).

But as individuals

We don’t have checks and balances unless we create them. Let me give you a few ideas on how to create self-monitoring mechanisms.

1. Budgets – A budget is a guide and benchmark against which you can weigh yourself.
2. Weekly or Monthly Financial Reviews – Set aside a time each week or month to review your finances with you spouse so that you both know what’s going on and can talk through any issues.
3. Cut up credit cards – Just remove the temptation.
4. Tell your mom about your goals – Okay, so maybe you don’t have to tell your mother per se. But tell someone that will check-up on you about your financial goals. Create accountability for yourself.
5. Automate as much as you can – Make your savings automatic. Make bill pay automatic. Make donations automatic. Get your money going to the right places as soon as you are paid. Then, only spend what’s left.

I’m happy to say that we are headed in the right direction again. But it’s still been costly. Hopefully, I won’t have to wait until it’s out of control again before making course corrections.

Can you empathize? If so, let me know in the comments or on Twitter.

Let me start by saying, I like Dave Ramsey. I am a Dave Ramsey fan. I’ve completed his Financial Peace University. I am prepared to “Live like no one else, so I can LIVE like no one else.” But I have to disagree with him on at least one account – no credit cards at all.

I advocate that you don’t use credit cards. My wife and I switched from putting everything on a credit card and paying the balance off each month to using a debit card. We closed 14 different credit and department store cards. It was one of the best financial decisions we’ve ever made. However, I still have one open credit card and one open department store card.

I have been asked if and when using credit cards makes sense. As a general rule, I tell people to never use a credit card. Mainly because many people don’t have sufficient self-control to manage credit cards. So don’t even put yourself in the situation to be tempted. However, if you can exhibit self-control, then there are three reasons I use a credit card.

My three reasons for using a credit card

1. Avoid multiple withdraws or overdraws from bank errors
   I don’t like someone having direct access and authorization to withdraw funds from my checking account. For example, I only put my electric, cell phone, and gas bills on my credit card. That’s it. I don’t use it for anything else. My reason is that I have known a number of individuals who had a bank or merchant, in error, make a withdraw several times or withdraw the wrong amount from their checking account. In 99.9% of the cases, you will get your money back. However, that mistake can be costly until it’s resolved. Maybe you won’t be able to buy food or you end up with overdraft fees.
2. True emergencies
   I really hesitate to even mention this reason since it can be too easy to call something an “emergency”. The purpose of an emergency fund is so you can cover emergencies and not have to rely on credit. However, you can’t always get to the funds in time. Let me give you a recent experience. A little over a month ago, I received a call at 1AM with news of a death in the family. Just 24 hours later, my family was on an airplane. We were gone for more than a week. Since we needed to book plane tickets, a rental car, hotel rooms, etc. in such a short timeframe, I relied on my credit card. Having said that, I paid off the total amount of the trip from our emergency fund within one week of returning home. But again, make sure it’s an actual emergency. As an aid, here’s a list of 49 non-emergencies.
3. Discounts or money back
   So I’ve explained why we have one credit card. I want to now briefly explain why we have one department store card – Kohl’s. We love shopping at Kohl’s. I actually interned a few years back at the corporate office and gained a real appreciate for the organization as a whole. As a result, we do a lot of shopping at Kohl’s and receive coupons each month for great discounts. The only requirement to get the discount – use your Kohl’s card. Since we’d be shopping there either way, we might as well get the 20-30% discount. Just make sure that coupons don’t end up costing you more money because you spent more than you would have normally.

If you use a credit card, do so sparingly and pay it off monthly

I really can’t stress this point enough. As I mentioned before, I usually just make the blanket statement that you should never own or use a credit card. But I’m a realist and recognize that there are situations when credit cards can make sense.

What other sound reasons might cause you to keep a credit card just in case?

For those unfamiliar with the Prisoner’s Dilemma, it’s essentially a hypothetical scenario where a prisoner has to choose between two alternatives – rat out his accomplice or say nothing. The prisoner selects which action to take based on the potential payoff or outcome from either alternative.

The Prisoner’s Dilemma is a common way to explain a branch of economics called Game Theory or Industrial Organization, popularized in the movie A Beautiful Mind. John Nash realized that to reach an optimal outcome, no participant can be made better off by choosing a different course of action. Essentially, everyone is in the best place that they can be.

So how does this apply to personal finance?

Let’s use credit card companies as an example. ACME Credit Cards has a large marketing department who has one simple responsibility – convince you that the optimal outcome is using a credit card.

So let’s use game theory to analyze the true payoffs of using and not using credit cards. I’ll then show you how ACME Credit Cards has distorted the truth hoping that you’ll choose a non-optimal solution (though certainly optimal for them).

Setting up the participants and outcomes

Step 1 is setting up the game with the possible choices that each participant has.

As shown above, Consumers have the option to either use credit cards or use cash for purchases. For the purpose of this illustration, I am narrowing the Credit Card Issuer’s options to make money from either interest charges or transaction fees charged to merchants (this assumes that the Consumer pays off the balance in full each month).

Step 2 is setting the payoffs that each participant can expect depending on the outcome of the choices made.

Here is a recap of the outcomes:

• If the Consumer chooses to use credit cards and not pay off the balance each month, then the Consumer pays interest charges and the Credit Card Issuer makes huge profits. Bad outcome.
• If the Consumer chooses to use credit cards and pay off the balance each month, then the Consumer still pays more since Consumers spend on average 18% more when using credit cards versus cash and the Credit Card Issuer still makes money. Bad outcome.
• If the Consumer chooses to use cash only, then he or she saves money and the Credit Card Issuer goes broke no matter what it chooses. Good outcome.
• Optimal Outcome: The Consumer should always choose to use cash instead of credit.

Step 3 is setting up the outcomes as Credit Card Issuers would have you believe them.

Here is a recap of the outcomes:

• If the Consumer chooses to use credit cards and not pay off the balance each month, then the Consumer  was able to get just what he or she needed when he or she needed it and the Credit Card Issuer is the good guy. Good outcome.
• If the Consumer chooses to use credit cards and pay off the balance each month, then the Consumer was still able to get just what he or she needed when he or she needed it and the Credit Card Issuer is the good guy. Good outcome.
• If the Consumer chooses to use cash only, then he or she misses out on all of the rewards and fun that everyone else is taking advantage of and the Credit Card Issuer goes broke no matter what it chooses. Bad outcome.
• Optimal Outcome: The Consumer should always choose to use a credit card instead of cash.

Avoiding the marketing traps

Do not be fooled by slick advertising. Although Credit Card Issuers paint a very pretty picture of instant gratification, reasonable fees and interest rates, and a mass of incentives (e.g. miles, points, cash back), the reality is that they are making a lot of money. Visa posted profits of $713mm just for the first three months of 2010!

Meaning, they are doing a great job of distorting the truth. As shown above, the actual outcomes are not fun and fancy free living. Rather, avoiding credit and debt is the sure path to financial stability and growth.

This same logic and process aptly works for other areas of personal finance as well. I just like picking on credit cards.

Also, listed below are several articles and ideas on how to avoid debt and save money:

• How To: Get out of debt using the Snowball Method
• 6 More ways to stop overspending
• The 30-Day “No Spend” Challenge
• 4 Changes to make in this new economy

What are some other examples where the optimal outcome is being distorted by clever marketing? Also, sign-up for our RSS Feed for timely updates on this and other financial topics.