The Psychology of Cash vs. Credit

I love credit cards. It may be a shock to hear a financial advisor make such a statement, but it’s true. Specifically, I love the games you can play games with credit card promotions. For example, without spending one dime of interest (or buying something I didn’t need), I have accumulated almost 500,000 reward miles from signup bonuses since the beginning of the year. Talk about fun!

Let me be perfectly clear. I do not love all things about cards. The easy availability of consumer credit, combined with a lack of financial education and personal discipline has created a cancerous effect on the personal balance sheets of so many Americans. Our society makes it easy (and acceptable) for individuals and families to fall into a trap of indebtedness. Credit cards are so dangerous because they (appear to) make life so easy. In fact, studies have shown that our brain actually views paying with credit cards differently than paying with cash.

According to a 2011 research paper from the The University of Chicago Press and Journal of Consumer Research Inc., the use of credit cards “as a payment mechanism increases the propensity to spend as compared to cash in otherwise identical purchase situations.” The researchers went on to say that, “When credit cards as a payment mechanism are more accessible, consumers attend more to a product’s benefits relative to the cost aspects of the product. Conversely, when cash as a payment mechanism is more accessible, consumers attend more to cost aspects of the product (broadly defined to include price, delivery time/costs, warranty costs, installation costs, etc.) relative to product benefits.”

In other words, the study found that we care much more about the price of an object when we are paying with cash than with credit. This certainly makes sense. Cash just seems more “real” to me for some reason, and harder to part with (as opposed to a number on a piece of paper that I’m asked to sign). In fact, I know that I have a much better recall of the total price of a meal when I pay cash then when I pay with credit.

It’s difficult to fully explain, but ever since my wife and I moved to a cash-based system for monthly budgeting, we have realized many tangible as well as intangible benefits. We both know where the money is going and we are both more restrained when it comes to our everyday “wants”. As much as I love the benefits of credit cards, I am a big believer in adopting a cash-based budgeting system (no matter your income level). You may think it will never work for your family, but don’t knock it until you try it!