That's how it goes, no one remembers you until they want something from you. Well maybe I want something in return...
Alright kids, time for 'ol Trimoor to clear things up.

This circuit will make an LED illuminate when the button is pressed. It will not harm an encoder, and is perfectly acceptable by engineering standards. It allows both the LED and encoder to share a common ground without frying one another. I have included robust labels for the electronically challenged. I have personally used this circuit, and can assure you it is safe and elegant. Just don't lick it.

This circuit is the one I made for cholin. It functions the same as the first, but it has an extra all-on feature. When idle, all the lights will be partly illuminated, with the brightness controlled by a single potentiometer. This can be anything from completely off, to completely on. When a button is pressed, that individual light will jump to full brightness, regardless of the potentiometer setting. Thus all your lights can be dimly lit, but each one will be bright when pressed.
Connecting an LED in series with an encoder is a bad idea. It could reduce the reliability, damage the LED with excessive current, damage the encoder with excessive current, and simply lacks elegance. We engineers always want the most elegant solution.
If anything goes wrong, be sure to blame cholin for giving me ideas.