A Credit Crunch Coming?

An old friend of mine has a quaint name for credit cards: plastico fantastico. Call it a sign of his free-spending ways, or a moniker to hide the thousands in debt he must carry. Whatever the reason, he's hardly alone. The Federal Reserve yesterday reported huge increases in borrowing, including the largest spike in credit card spending since October of 2004.

Consumer credit, which is defined as non-mortgage loans to individuals, rose by $4.4 billion during May, easily surpassing the Fed's estimate of $3 billion but lower than April's $9.3 billion increase.

But that's the good news. The bad is that revolving credit, which generally includes credit cards, jumped by $6.7 billion, or 9.9% annually, during May. That blew away April's $1.9 billion increase, and it represented the largest jump since October 2004, when revolving debt climbed by $8.8 billion.

The danger of such situations is that consumer spending generally accounts for two-thirds of the economy. It can't be forever sustained through credit. Buying power must also come from higher salaries, entrepreneurship, or other value-creating activities. Without them, the economy is likely to cool, and that could impact consumer discretionary stocks such as Comcast (Nasdaq: CMCSA  ) , Yum! Brands (NYSE: YUM  ) , and other entertainment and fast-food businesses.

Of course, I'm not suggesting you stop investing. Instead, here are three brief bits of advice for insulating yourself from the potential fallout of a plastic economy:

1. Get diversified. Low-cost funds are a remarkably cheap way to earn superior returns while exposing your portfolio to a wide array of industries. Take Vanguard Windsor II (FUND: VWNFX  ) , for example. It's a large-cap value fund that holds dozens of stocks and has returned more than 24% since joining the Motley Fool Champion Funds portfolio two years ago.

2. Use dividends. It's no accident that cigarette-maker Altria (NYSE: MO  ) has been one of the best-performing stocks of the last five decades. Professor Jeremy Siegel proved that the best stock market returns come from reinvesting dividends in steady performers like Big Mo.

3. Keep a cash cushion. For investing and personal security, it pays to have cash available. Three to six months worth of salary is typically a good rule of thumb. Had I followed that advice, I wouldn't be $60,000 in debt today.

Credit cards can be very useful. But these are particularly dangerous times for borrowers and investors alike. A Fool should always prepare for the worst.

Looking to make the most of your moola? GiveMotley Fool GreenLighta try. An all-access pass to the service costs only theprice of a click, and there's never, ever any obligation to buy.

Fool contributorTim Beyershas witnessed plastico fantastico become plastico disastro. Tim didn't own shares in any of the companies mentioned in this story at the time of publication. You can find out which stocks he owns by checking Tim's Foolprofile. The Motley Fool has an ironcladdisclosure policy.

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10/27/2016 4:00 PM
CMCSA $61.48 Down -1.08 -1.73%
Comcast CAPS Rating: ***
MO $64.43 Down -0.09 -0.14%
Altria Group CAPS Rating: ****
VWNFX $35.13 Down -0.04 -0.11%
YUM $85.36 Down -0.37 -0.43%
Yum! Brands CAPS Rating: ****