When you’re in the checkout line and use your credit card, you may notice it feels different than when you hand over cash to make your purchase. When you swipe plastic, it may not feel like you’re spending real money at all. This turns out to be a pretty common feeling, and research shows that people are more likely to overspend when they’re paying with a credit card instead of cash.
Why is this the case? One reason could be that using cash to make your purchases is a much more transparent process than using credit. You have to take money out of your wallet and hand it to another person. You see the amount you have in your wallet decrease, and the weight of that transaction takes a toll. On the other hand, when you’re paying with a credit card, you’re essentially kicking the can down the road. You might not notice your card balance at the time of purchase, and you don’t pay your bill until the end of the month.
Here’s a look at the thought process behind using cash vs. credit cards and how that mindset can lead you to more unintentional spending.
Several studies have shown a clear link between credit use and increased spending. One of the most famous studies comes from Drazen Pralec and Duncan Simester at M.I.T. The pair set up an auction for tickets to desirable sporting events. Participants were restricted to using either cash or a credit card to bid on the tickets. The pair found that those using credit were willing to pay up to twice as much as cash buyers for the tickets.
Other studies have found even greater disparities between cash and non-cash payments. One study by the Federal Reserve Bank of Boston found that the average cash transaction value was $22, while the average non-cash transaction was $112.
The psychological reasoning behind these behaviors may lie in a concept known as mental accounting and behavioral biases, such as loss aversion.
According to the theory behind mental accounting, people place different values on the same amount of money according to subjective criteria, such as where the money came from or its intended use. In other words, they don’t think of all the money that they have as coming from the same pot, so they may treat cash and credit differently.
Consider a now-classic experiment from two pioneers in behavioral economics, Daniel Kahneman and Amos Tversky. Participants were asked to consider two scenarios. In the first, they were asked to imagine they purchased a $10 ticket for a play in advance, and upon arriving at the theater, they realized the ticket was lost. They were then asked if they would purchase a replacement ticket.
In the second scenario, the individual was asked to imagine they hadn’t bought a ticket yet. When they arrive at the theater and open their wallet, they realize they’ve lost $10. They are asked if they would still buy a ticket for the play.
More than 88% of people were willing to buy a ticket in the second scenario, while half as many were willing to do so in the first scenario. People in the first scenario felt the ticket price had doubled, even though the bottom line in both scenarios leaves the individual out $20. The individuals in scenario one had already accounted for how much they were willing to spend on a theater ticket. When they saw the cost double, the situation became untenable.
Other behavioral biases may come into play as well. Credit card spending creates space between a purchase and the actual payment, decoupling the two in individuals’ minds. Credit card spending lessens the effects of a behavioral bias known as loss aversion — the tendency to feel losses more acutely than gain. Because individuals don’t see money leaving their hands when using a credit card, the effects of loss aversion are reduced.
When these biases come into play, individuals who use credit cards may spend more on things they don’t need, or can’t afford. Because there’s a delay between the purchase and the pain of payment, credit card users may be more likely to make impulse purchases and run up credit card debt.
Using cash, on the other hand, can be quite a different experience for consumers. Cash buying increases a phenomenon known as “pain of paying” as consumers see money leaving their hands. Turns out this isn’t just a metaphor: Consumers actually feel psychological pain when spending with cash, which decreases willingness to buy, according to one study.
On the plus side, there is evidence that paying with cash increases the connection individuals feel to the product or service that they’re purchasing. In fact, people who use “painful” forms of payment are more emotionally attached to products and are more likely to make repeat purchases of products.
Despite the potential pitfalls of using credit cards, it is still useful in a number of settings if done so responsibly. Chief among these is travel. Credit cards are widely accepted in the U.S. and abroad. They are useful — and sometimes necessary — when you rent cars, book hotels, and buy plane tickets. Credit card transaction fees may be cheaper than the fees you’ll pay to withdraw cash when traveling overseas. If your card gets lost or stolen, your credit card company will have your back. You can dispute any fraudulent charges, as well as cancel or freeze credit cards to prevent additional fraud.
Using credit cards wisely can also help you build credit. Credit card companies submit your activity to the credit reporting bureaus, and a track record of paying your credit card bill on time can boost your credit score and demonstrate your creditworthiness to would-be lenders.
Generally speaking, paying in cash can be useful in a few scenarios. Retailers must pay credit card companies to execute transactions; they lose a portion of money on every credit card purchase. As a result, some retailers may offer discounts for cash purchases.
If you have a hard time paying your credit card off in full every month, consider switching to all-cash spending, leaving your credit card at home. (You may even want to put your credit card in an inconvenient place to discourage using it.)
If you are someone who tends to spend more than they can afford, consider switching to cash and use the behavioral biases discussed above. Cash can trigger both loss aversion and the pain of paying to help keep you from overspending.
Unfortunately, a number of behavioral and psychological tendencies make credit card spending feel easier than paying with cash. This may not be a huge problem if you can spend within your means and pay your credit card off in full each month. But, if you aren’t disciplined, using your credit card can land you with a mountain of debt you may have a hard time paying off.
When it comes to paying for things, it may not be as simple as “Is it better to pay cash or a credit card?” However, being aware of the behavioral tendencies can help you spend wisely and balance using a credit card and cash appropriately.
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