With the holiday buying frenzy in full progress, there is no better time than the present for some money saving strategies. One of them is simple, easy, and free–using the right credit card to make holiday purchases. Yes, credit cards can save you a bundle this holiday season, but only if you use the right card and use it the right way. So here are some tips on how to pick the right holiday credit card and use it responsibly to save a lot of money.

Pick the right holiday credit card

Saving money with a card starts by picking the right kind of credit card for purchases. The best cards for holiday purchases fall into one of two categories: cash back rewards cards or 0% APR cards.

With cash back rewards credit cards, you get a statement credit or cash back based on the amount you spend. This is the easiest way to save money during the holidays. Simply use a cash back credit card, and you’ll save as much as 5% or more on your purchases based on the cash back reward offered by the credit card.

The second option is to use credit cards with 0% APR offers on purchases or balance transfers. With this option, you save money by paying off your holiday purchases over time interest free. And some of the best 0% balance transfer credit cards also offer 0% APR on purchases.

The balance transfer option can allow you to save money twice. Here’s how. Many stores like Macy’s or Kohl’s will offer discounts if you use their store credit card. I know because my wife takes advantage of these discounts all the time. With a balance transfer card, you can take advantage of the store discounts, and then transfer the balance to a 0% card.

Best cash back and 0% credit cards

So now the question is which credit cards offer cash back or 0% APR deals that are great for holiday shopping. Here are three to consider, two of which are Consumer Reports picks for the best cash back credit cards.

1. Discover More Card:

This card offers up to 5% cash back with no annual fee. And if you shop on Discover’s online shopping site, you can save as much as 20%. The More card also offers a 0% APR introductory rate on balance transfers and purchases. This card was a Consumer Reports rewards card pick.

2. 12 Month 0 Balance Transfer Citi Premium Select

At up to 12-months, the Citi Premium Select offers one of the longest balance transfer offer currently available. It’s regular APR is competitive, and it comes with no annual fee.

3. Blue Cash from American Express

Blue Cash is another Consumer Reports pick. The card offers up to 5% cash back, no annual fee, and 0% interest on purchases for up to 12 months.

Remember not to overspend

As rewarding as some credit cards can be, we must resist the temptation to overspend. Studies have shown that some people buy more with credit cards than they would with cash. Particularly with cash back cards, care should be taken not to buy more than you need. No matter how good the credit card deal is, you still have to pay back what you spend. So while these cards can save you money during the holidays, we still have to use them with care.

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In a typical secondary market, the net present value of a loan depends on the expected future cash flows and a discount rate. The discount rate is the interest rate on the loan often with an additional risk premium. When interest rates fall, the net present value of existing loans will rise. This is because older loans were originated at higher rates and are more valuable. When interest rates rise, the net present value of existing loans falls since new loans can be originated at higher rates and provide greater cash flow.

I have a feeling that at least initially, the Prosper market will not behave like a typical secondary lending market. I think that either one of two things will happen:

1. People that regret having tied up their money for 36 months will put their loans up for sale. In desperation they may be willing to accept very low prices for the loans. This will present a great opportunity for investors to purchase higher yielding loans.
2. People will be greedy and attempt to sell their loans for much higher prices than they are worth. Investors will not bother buying them since they can just originate more attractive loans. It would be an illiquid market, very much like the broader credit markets are right now.

It will certainly be interesting to see exactly what happens. Perhaps neither will happen and the market will function in a relatively normal manner. I’m sure that Prosper will probably provide some tools to provide guidance to those selling loans to ensure some liquidity within the market. Prosper will want the market to be as liquid as possible, because they will very likely receive fees for sales within the secondary market.

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• Basket of 7 (small – med size) tomatoes: $2.00
• Basket of green beans: $2.00
• 4 Golden Delicious Apples: $1.00
• 4 Red Apples: $1.00
• 2 Large Red Onions: $1.00
• 2 Large Onions: $1.00
• 10 Yellow Squash: $2.00
• 5 Cucumbers: $1.00
• 4 large Zucchini: $2.00
• 2 large Green Peppers: $1.00
• 2 large Red Peppers: $1.00

The cost of living where we live (Jacksonville, Florida) is relatively low, but regardless it provides a substantial savings on what these items would cost us at the grocery store. My wife says this shopping list would have easily cost double at Publix (the preferred grocery store in Florida), and the quantity of items would probably have been smaller. To ensure nothing goes to waste she cut up and froze a portion of the beans, squash, zucchini, and peppers. The onions can be cut and frozen as well, but we plan on using them soon. I still swear by the farmer’s market, and I highly recommend you check out the nearest one to you. It could save you hundreds of dollars a year on your grocery bills.

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The U.S. government had originally said it would loan AIG, once the world’s biggest insurer, $85 billion, but increased that to $122.8 billion on Wednesday as the company races to sell assets to pay off the loan before the credit turmoil makes buyers harder to come by.

When I read this it made me sick to my stomach. Not because of the staggering sums of money being lent to AIG, but because it is not a government loan. My initial thought was correct, as AIG has never received any government loans. Granted Reuters is a British based company, but you would think that if they are going to report on U.S. financial news, they would ensure that their reporters understand the Federal Reserve System.

Unfortunately I would seem that such errant reporting is not limited to foreign reporters. Earlier this week, the New York Times reported that the Fed is purchasing commercial paper to provide some additional liquidity to the credit markets (I came to learn of the NYT article from MyTwoDollars). Within the New York Times article the authors state:

While the move will put more taxpayer dollars at risk, it underscores the growing sense of urgency felt by policy makers in a climate where lending has virtually dried up.

I’m not exactly sure how it puts more taxpayer dollars at risk, because the Federal Reserve is independent within government, and generates its own revenue with Open Market Operations. If you look at the Federal Reserve’s 2007 income statement, you’ll see no line items that indicate income from taxes. If the Fed incurs any losses, they would be losses for the Fed not taxpayers.

With all of the recent focus on the Emergency Economic Stabilization Act of 2008 (aka the $700 billion “bailout”), the media finds it convenient to label everything as a government-sponsored act. It is sensationalistic and inaccurate to equate the actions of the Federal Reserve as actions of the U.S. government. The next time you see the Federal Reserve and the U.S. government mentioned within the same article, be sure to take what you read with a grain of salt. It is likely that the author may not really understand how the Federal Reserve System works.

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So why are the stock markets down in response to the passing of the bill? Although the bill has passed, the fact remains that credit markets are still failing and it is still difficult to borrow money. The credit markets really act as a fuel for the economy, as they make capital readily available that otherwise wouldn’t be. Capital allows companies to make capital investments (purchase of plant & equipment, i.e. long-term assets) for corporate growth which results in economic growth as well. Consumer credit also allows consumers to make purchases they may not otherwise be able to make if they could not repay them over time. This also helps to stimulate the economy. Without credit the economy suffers. The market value of stocks is fundamentally based on future cash flows (how much money companies are expected to make and grow), so when the economic outlook is poor stock prices will suffer.

It will take time before the situation in the credit markets improve and ultimately the stock markets improve as well. So what can you do to protect yourself? That of course depends on your overall situation and your tolerance for risk. If you are in it for the long haul and you have long positions on some stocks or exchange traded funds that you do not intend to sell, you might want to consider selling covered calls. The VIX (CBOE Volatility Index) is currently over 50, which means that huge premiums are being paid for options. This is premium you could pocket by selling covered calls.

However, one problem with this strategy is that if you are below your cost basis (very likely), you would be locking in losses by selling calls at strikes below your cost basis, if a miraculous recovery takes place before the expiration of the option you sell. If it takes a long time for the stock markets to recover (which I believe it will), you can sell slightly out-of-the money covered calls month after month and help to some of your losses and use your positions to generate income. Another problem with the strategy is that if the stock markets continue to fall rapidly, you’d just be better off liquidating your positions rather than trying to use covered calls for income. The income from the covered calls may not be sufficient to recover continuing losses.

If selling covered calls doesn’t sound like your cup of tea, but you are still in it for the long haul then you probably should simply do nothing. If you can’t stand watching your portfolio continue to fall, you may want to consider selling off and holding on to your cash in an FDIC insured account. If retirement is a long way off, you should continue to contribute to your 401k and IRAs. If you can afford it, you might even want to try increasing your contributions a bit. If you are approaching retirement, hopefully you’ve adjusted your asset allocation accordingly and your portfolio is not heavily weighted in equities. There is one thing I’m certain about and it’s that the stock market will eventually recover. Even in the worst of times, they always do. I take solace in that and you should too.

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I was watching the news last night and it was rather upsetting to listen to a member of Congress speaking about the issue in terms of what was taking place in the stock markets.  He spoke as if the purpose of passing the bill was to increase market value and restore losses experienced in 401k accounts.  Most politicians blaming are Wall Street for the woes in the credit markets, when in fact Wall Street has very little to do with it.  It is unsettling when those drafting legislation of such magnitude do not appear to understand that the securities markets and credit markets are two separate markets.

Politicians are quick to blame lack of oversight and immoral CEOs for what has transpired, when in fact it is really no one’s fault.  When capital becomes available as easily as it did over the past several years, one should expect a lot of lending to take place to the point where even unqualified individuals are receiving substantial loans that they are incapable of paying back.  If anything is to blame, it is the monetary policy of the Federal Reserve from several years ago.  If any government oversight should be put into place, it should preside over the actions of the Federal Reserve Board, not the banks.

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Avocado, grapefruit and spinach salad

I will agree that the situation is poor, but I do not think it has yet reached cataclysmic proportions. Many say that the financial system is breaking down, but I say that it is a free market that is working just as it is supposed to. The cost of interbank borrowing has risen, but for good reason. If a bank wants to borrow from another to meet reserve requirements, but there is more risk than there is under normal circumstances, the lending bank needs compensation for that risk.

Unfortunately, the media has made the situation even worse. I believe that is a big reason why Washington Mutual has collapsed. People begin to panic that their bank is going to close its doors (even though more than likely, the deposits those people have are well below the FDIC insurable limits), so they take out all their money. When the deposits drop, the bank needs to increase reserves so it has to borrow. With the cost of borrowing high and sources of capital diminishing, it becomes impossible for the bank to maintain solvency. I think the media had a big effect on sending people to their branches to take out all their money and stuff it under their mattresses.

I was actually pleased to learn this morning that talks on the bailout package are breaking down. I believe that the vast majority of Americans do not want such a bailout to take place. Everyone I hear talking about this issue around the water cooler says they do not want it to happen. Let’s hope that Congress will lend an ear to constituents, and not pass legislation that will cost us for generations to come. A breakdown in the democracy in which this great nation was founded would be far worse than failure of the financial system.

What exactly does that mean? Perhaps the easiest way to explain it and understand it is with a good example. Here’s an example inspired by a post David at MyTwoDollars made in which a reader asks whether to pay off a car loan or increase the down payment on a new home:

My husband and I are selling our house and will be netting a profit of $52,000. We are building a $300,000 house and were wondering if we should pay off a Tahoe for $12,000 so we can get rid of a $600 payment or should we put all $52,000 into the new house. I guess I’m asking what the pros and cons would be. Thanks

Unfortunately the reader did not include additional information necessary for my example, namely the interest rates on the car loan and mortgage. I will take the liberty of fabricating the interest rates and some other information. Here are the assumptions we will make for the first part of the example:

• Auto loan balance: $12,000
• Auto loan interest rate: 0%
• Total monthly auto loan payment: $600
• Auto loan total term: 36 months
• Auto loan remaining term: 20 months
• New home purchase price: $300,000
• Down payment on home: $52,000
• Amount borrowed for home purchase: $248,000
• Interest rate on mortgage: 6%
• Mortgage term: 30 years
• Total monthly mortgage payment (principal and interest): $1,486.89
• Auto loan is paid off and money is not used for down payment on home purchase
• After auto loan payoff, monthly cash outflow is $1,486.89

In order for my example to work, I had to make the rather outrageous assumption that the vehicle was purchased with 0% financing. So if the auto loan is paid off the monthly cash outflow will be $1,187.11. Now let’s see what happens if we keep making payments on the vehicle for the remaining 20 months, and use the $12,000 to increase the down payment on the new home:

• New home purchase price: $300,000
• Down payment on home: $64,000
• Amount borrowed for home purchase: $236,000
• Interest rate on mortgage: 6%
• Mortgage term: 30 years
• Total monthly mortgage payment (principal and interest): $1,414.94
• Auto loan monthly payment: $600
• Monthly cash outflow: $2,014.94

Most people would tell you that paying off the car loan will help save $528.05 every month and over the course of 20 months would save a total of $10,561. However, I say that paying off the car loan will actually cost a total of $1,188.30 in terms of overall savings and accumulation of wealth. Certainly I will agree that cash flow will improve by $525.05 every month. However, by reducing the down payment on the new home by $12,000, it will actually cost more to pay off the car loan:

• Total interest paid on a 30-yr. loan for $248,000 @ 6% over 20 months: $24,558.27
• Total interest paid on a 30-yr. loan for $236,000 @ 6% over 20 months: $23,369.97
• Difference: $1,188.30

Keeping the car payment results in a higher net worth after 20 months, because the interest rate on the car payment is lower than that of the mortgage (now you see why I made my outrageous assumption of 0% financing on the vehicle). In terms of accumulating wealth, keeping the car payment is the more prudent decision. However, the majority of people would prefer to improve their monthly cash flow and pay off the vehicle. More often than not, individuals will sacrifice accumulating wealth in order to improve cash flow. Consequently this is the reason why most people never achieve financial independence.

The bottom line: if you ever have the opportunity to pay down loan balances, you should pay balances with the higest interest rates first. You may be tempted to pay off the balance on a loan with a lower rate if the monthly payment is higher than the payment on a loan with a higher rate. Afterall, it would result in better cash flow to do so. However, it would not result in the most favorable net worth to pay off a lower rate balance first. Let’s look at another example with some smaller numbers:

• You have a 36-month personal loan @ 10%
• Monthly payment on personal loan is about $260.
• Original personal loan amount was for $8,000.
• Remaining balance on personal loan is about $3,000.
• Remaining term on the personal loan is 12 months.
• You have another credit card with a $5,600 balance @ 18%
• Credit card has a monthly payment of $120.
• Total monthly payment for both loans is $380.
• You receive $4,000 for your annual bonus. Which balance do you pay off/pay down with the $4,000?

I contend that most people would probably opt to pay off the personal loan, because it would result in a better cash flow improvement. However, paying down the credit card instead would result in a higher net worth. Let’s compare the difference in interest paid over the next 12 months (the remaining term of the personal loan):

As you can see, by paying the lower interest balance first ends up costing more in the long run. Although cash flow improves over the next 12 months, you pay more in interest expenses and are left with a higher debt balance in month 13.  A higher debt balance means you have a lower net worth. Not only do you pay less interest in months 1-12, but you will pay less interest in subsequent months and debt will be eliminated faster.  So remember, if you can afford to do so, pay down your loans with the highest rates first.

New Loan Funded — payoff current loan and new invest on business — $25,000 at 29.00% — E Credit — DTI 37%

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1. It will undoubtedly cause a short squeeze (as we began to see yesterday with the Dow rising 400 points). A short squeeze takes place when there is a lot of open short interest (a lot of people shorting a stock) and the stock begins to rise.  As the stock rises, many short sellers buy back the stock to prevent or cap their losses.  With many short sellers buying back the stock, it increases the demand for the stock and a snowball effect takes place as the stock skyrockets.  Many short sellers will receive margin calls and will either have to increase the value of the assets in their account or be forced to buy back short positions at a loss.
2. It does absolutely nothing to solve the problems that are causing financial stocks to drop in the first place. Financial firms have seen their market value falling because of the difficulty they are facing in finding sources of capital.  The cost of borrowing for lenders and banks has increased due to the credit crunch.  Banning short selling on financial stocks does absolutely nothing to resolve the fundamental issues that have caused the market value of financial firms to fall.

The action taken by the U.S. and U.K. regulatory agencies are likely to cause more problems than they will solve.  It will only increase the volatility in the stock market as a short squeeze takes place and after the ban is lifted.  After the ban is lifted, we will likely see the financial stocks drop once again.  Why?  Because the underlying issues still exist and the market will value the price of those financial institutions accordingly.  The day traders are going to really have a field day as they buy up shares of financial stocks and subsequently short them after the ban is lifted.

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