Articles and books on personal finance generally pack in as many tips as possible in an effort to make at least a couple essential ones stick. This shotgun approach is worth it if it helps readers learn to pay themselves first, spend less than they make, and so on, but saying too much sometimes means explaining too little.
In this article we'll focus on just one technique to improve your finances by taking a close at how making purchases with cash can contribute to your ability to budget, save and invest.
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A Plastic Paradise
With the proliferation of plastic alternatives to hard currency, some people consider carrying cash a throwback.
To be fair, plastic is much sexier than a piece of colored paper with a dead president staring vaguely into the distance. Some banks even allow you to customize the graphics that appear on the credit card/debit card or choose from a range of designs and colors the company is marketing.
There is also the security advantage with debit and credit cards. Debit cards are protected by your personal identification number (PIN) and credit cards by your signature (and for some cards, a PIN number too). Cash is only protected by your ability to defend it should someone else want to take it from you.
Moreover, cards are as widely accepted as cash - with the exception of a few mom and pop shops. And yet, from a personal finance view, cash is almost always the better choice for making a purchase. Here's why:
One of the drawbacks of credit and debit cards is that they encourage you to spend more than you intend to by giving you easy access to more capital. With cash, spending more than you intended requires going to a bank or ATM to get more and then going back to the store to complete the purchase. For most people, this provides time to reconsider whether their budgets can handle any extra strain.
Generally speaking, only carrying the cash you are prepared to pay for a given product will prevent you from buying the next level up and paying for features you don't need. This works for small-scale purchases, but buying a computer or a car can involve large amounts of cash that probably shouldn't be carried around. If a check can't be used, a debit card is better than a credit card because you are spending money you have rather than money you don't.
Just as cards encourage overpaying for one item, they also allow you to buy more items than you mean to. Stores are set up to make products appealing in order to persuade shoppers to buy more. Sometimes a shopping list isn't enough to protect you from impulse buys.
According to the article "Cards Encourage You to Overspend" on Soundmoneytips.com, people will spend more with a credit card compared to cash. In fact, a Dunn & Bradstreet study found that people spend 12-18% more when using credit cards than when using cash. And McDonald's found that the average transaction rose from $4.50 to $7 when customers used plastic instead of cash.
So what can you do to avoid this? Only carrying enough cash to buy the things on your list can limit the damage. This is the best way to keep shopping within your budget. If you are motivated, you will find discounts or cheaper alternatives to your regular brands to make that cash go further and maybe earn yourself a luxury item.
3. Cash Vs. Credit Cards
Cash, for the purposes of this article, is strictly limited to money you have already earned and is sitting there for you to use. Using your Visa to take a cash advance and then carrying the cash with you will not solve the essential problem of using high-interest debt to cover your expenses.
Cash has one very clear advantage over using a credit card: If you buy something on your credit card and end up carrying a balance, or only make the minimum payment each month, you will incur interest at a rate of 15% or more of your purchase (which can have you paying $15 or more for every $100 you spend). If you save up enough cash for the same purchase, you are giving yourself the equivalent of a 15% discount by not using your card. Before you even sign up for a card, make sure you know what you're getting into.
4. Cash Vs. Debit Cards
If this article were only dealing with cash as a better alternative to credit cards, no one would dispute it. In contrast, debit cards seem to enjoy a protected status despite the overkill on ATM fees and foreign ATM fees. Forgetting the fees, a debit card's main failure is that is trivializes purchases. Being a square of plastic, it is hard to tell how much of your money is flowing through your debit card.
For most people it becomes a matter of $2 here, $6 there, another $4 over here and so on until they give up keeping track of how much has been spent in a day - let alone a month. Then it's a shock to their systems when the monthly statement comes and it's far too late to do any good. With cash, you can see the damage as it is done and hopefully curtail your spending before it gets out of control.
The Bottom Line
Using a credit or debit card offers more security than cash in most cases. For large purchases, carrying cash is often not an option and writing a check or getting a bank draft may be more trouble than it is worth for some. Furthermore, if a debit card is used responsibly, it is an ideal replacement for cash. A credit card can also be a convenient tool, but it's only a fair substitute for cash when the balance is paid in full at the end of each month. Otherwise, your ultimate reward for paying with your credit card will be paying off an even bigger debt.
If you struggle to avoid overspending, shopping with cash is one way to stick to your budget and limit impulsive spending.
If you still have budgeting questions, check out our Budgeting 101 feature.