Several popular personal finance gurus have recently insisted on some pretty extreme financial fixes. Specifically, they call for an end to credit and debit cards, insisting that "cash is king" on all roads to financial stability. With an understanding that an individual's spending habits will be unique, however, it's worth looking into whether the one-size-fits all approach to cutting out temptation and reigning in debt is really all that effective. (Pulling your money out of the market may help you sleep at night, but is it a smart move? See Stashing Your Cash: Mattress Or Market?)
TUTORIAL: Budgeting Basics
There are obvious perks to setting up a budget with solely cash. The "envelope method," for example, requires consumers to set aside enough cash for each anticipated budget category and spend it from each envelope as they need it. If the cash runs out, you can no longer buy for that particular category. Even if you don't choose to divvy up your dough into specifically marked piles, it's easy to know when you've spent enough for the week, as you will have no cash left. An empty wallet means you'll just have to wait for that next dinner out.
There is also a competitive advantage to using cash, according to Judy Woodward Bates, AKA, the Bargainomics Lady. "Cash can give you a negotiating edge with sellers. Ask for a discount for paying cash, and ask for a manager if the salesperson can't or won't negotiate." Judy insists that the worst thing they can tell you is "No!"
Judy also acknowledges that there is an emotional bond between us and our hard-earned cash. "Even though we know psychologically that the debit card is also cash, we don't have to physically see the money and, therefore, it's easier to let it go, to spend it," she admits. "With a credit card, we know we're spending and we know we're creating debt, but it's something we don't have to deal with in the present."
Consequences, therefore, are often pushed off onto the later, making it easy to overspend. (Avoiding all forms of plastic payment can do wonders for your stress level and pocket book. Check out Should You Pay In Cash?)
For some, however, cash can create as many problems and opportunities. Noah Rosenfarb, a CPA at Freedom Divorce Advisors in Short Hills, NJ, admits that while cash can be effective for managing debt, it also has some serious downsides. "Carrying cash means you need to know how much to have in your wallet and if it's lost or stolen, there is no protection to get it back."
In addition to being difficult to account for in the case of a crime, it can also be hard to track in other instances. Noah mentions the annual credit card statements that many of us rely on to break out annual purchases into categories, so you can have an easy organization of your expenses. These statements can be vital for tax time, mortgage applications or in the unfortunate case of a divorce.
There is also a lack of incentives that many of us adore in our credit cards. "Using cash means you don't get the benefit of points or rewards, which are usually 1% of your charges," adds Noah. While many consumers don't consider a percentage point to be worth the risk of racking up debt, those that can be responsible with their money (and have good enough credit to shop around for competitive loyalty offers) can see significant returns due to the thousands of dollars in everyday annual expenditures.
The Bottom Line
A combination of cash and credit, in conjunction with a defined budget, can offer the best of both worlds. Mr. Rosenfarb offers this compromise to consumers who are leery of choosing one over the other: "We advise using credit cards for recurring monthly bill payments (telephone, gas, electric, etc.) But when it comes to discretionary spending (clothes shopping, dinner out, movie night, etc.), we find cash is an easier way to track what you're spending."
It may also be wise to put certain expenses that could receive extra protections from a credit card company on plastic, as well. Car renters, for example, may choose to decline the optional and added expense of extra insurance coverage through the dealer if they know that their credit card policy will cover them for free. If there is a valuable added benefit to charging it - and then paying it off immediately - the card may trump your cold hard cash. (A decade before Mastercard or Visa existed, the first credit card company was introduced. Refer to How Credit Cards Built A Plastic Empire.)