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There is an old saying that “if your outgoing exceeds your income, then your upkeep will be your downfall”. In other words, if you live beyond your means, then things are bound to come unstuck.
And this is why you need to be careful of credit. Credit cards can be a big part of the problem because they can give us a false sense of security about our ability to afford a certain lifestyle.
However, if used correctly they can still play a useful role in helping manage the household budget.
Before we get into the finer points of how best to use them, let’s firstly take a sobering look at the impact credit cards have had on household debt.
Australia’s credit card addiction
Australia’s credit card debt continues to grow steadily and outstanding balances have more than doubled over the last 15 years. The Reserve Bank tells us that the $15.3 billion of credit card debt in 2002 had grown to $32.5 billion by March this year. The number of credit card accounts over that period has also mushroomed from around 10.5 million in 2002 to around 16.7 million this year and the average balance on those accounts climbed from around $1540 to just over $1900 per card.
The case for using cash
If the temptation to pound the plastic has left you in a debt spiral, then one option is to go ‘cold turkey’ and make the switch to a cash-based system for everyday spending. The tangibility of cash can have a profound psychological impact. It forces us to think more critically about what things cost and whether it is really something we need.
If you do want to make the switch to cash then it helps if you nominate the types of spending that you will use it for. Typically the best areas to target are the problem areas of discretionary spending, such as groceries, entertainment, clothing and eating out.
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It may also help to use a system that can help you manage spending, such as an envelope system. This involves having a separate envelope for each category of expense (eg petrol, groceries, entertainment and clothing), to which you allocate a weekly amount to put in each envelope. Then as you spend the money, put the receipts into the same envelope so that you can review where the money has gone at the end of the week and make any adjustments to the budgeted amounts.
This system may seem overly pedantic at first, but it is excellent for changing the way you think about spending.
Making credit cards work for you
For those of us who don’t want the manual restrictions of using cash, credit cards can be just as effective as a means of managing cashflow, as long as you stick to a few simple rules.
First and foremost, you need to commit to paying the balance off each month. If you already have a balance built up, then you need to stop using your cards completely until that balance is paid off. This gives you a clean slate to start with.
Once you have existing debt under control, you then need to work on a budget that ensures you live within your means (there is no way around this step if you are serious about using credit cards correctly).
Once your budget is documented, you can then use your credit card for all spending during the month, while income accumulates in your bank account ready to pay off the card balance at the end of the month. This method is particularly useful for those who have irregular income or have lots of expenses at the start of the month.
One of the key advantages of using credit cards to manage cashflow is that many cards will have reward point schemes that allow you to accumulate points for all spending and redeem those points for travel, merchandise, entertainment or even cash back payments. As long as you stick to the plan of paying off your full balance each month, these rewards can be well worthwhile. If you don’t pay off the balance regularly, however, then it is unlikely that the value of the rewards would even come close to amount of interest that you will be paying.
Using this method also gives you the advantage of accumulating interest in your bank account until the credit card payment needs to be made at month’s end.
The bottom line
Whether you use a cash or credit card system to manage your cashflow, the bottom line is that you need to budget your spending first to stay within your means. Once you have that in hand, credit cards can be a more convenient and rewarding spending alternative.
Need help? If you need support with budgeting, it may be worthwhile speaking with a financial planner who can help with a budgeting system that will suit you and can be built into your wider financial planning. It is important to start on the right track.
What are your tips for budgeting and cashflow? Share your thoughts below.