Paper or Plastic?

By Ben Dolan, CFP®

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At the end of Q1 2023, total US credit card balances hit $986 billion, the highest level since the New York Fed began tracking in 1999 (see full trend in data table below). Given the increase in interest rates and challenges with stubbornly high inflation, it may not be very long before total credit card debt eclipses $1 trillion. According to wallethub.com, the average credit card interest rate is 20.88%, and the average interest rate of new card offers is 22.51% (ouch!).

You may not be surprised to know that those who spend via credit card tend to spend more than those who pay with cash. This point has been proven many times over. What may surprise you, however, is the extent to which overspending occurs when paying with credit card versus cash. Gary Belsky and Thomas Gilovich explore this trend in their book on behavioral economics, Why Smart People Make Big Money Mistakes:

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Consider an experiment conducted several years ago by Drazen Prelec and Duncan Simester, marketing professors at the Massachusetts Institute of Technology in Cambridge, Massachusetts. The pair organized a real-life, sealed-bid auction for tickets to a Boston Celtics game (this was during the Larry Bird, Kevin McHale, Robert Parish era, so the tickets were especially valuable). Half the participants in the auction were informed that whoever won the bidding would have to pay for the tickets in cash (although they had a day to come up with the funds). The other half were told that the winning bidder would have to pay by credit card. Prelec and Simester then averaged the bids of those who thought they would have to pay in cash and those who thought they could pay with a credit card.

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Incredibly, the average credit card bid was roughly twice as large as the average cash bid. Simply because they were dealing with plastic, with money that was devalued in some way – the students became spendthrifts. Put another way, credit cards turn us into big spenders in more ways than one. We become poorer because we’re more likely to spend, and more likely to spend poorly (pg 43).

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Now, consider the fact that we don’t even have to get off the couch to spend in the age of e-commerce. Impulse buys are in front of us constantly as we navigate social media or read the news. And, since the apps on our phones are listening to our conversations, often these offers are for items we are currently seeking in the market. Without the confines of a budget, one-click spending can lead to unpaid credit card balances quickly.  

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Unfortunately, the impact of credit card balances may go beyond our financial health. As reported in the New York Times by Ann Carrns in a October 2021 article, credit card balances may have an impact on your overall health: The stress of carrying card debt through adulthood is linked to poor health, including joint pain or stiffness that interferes with daily activities, a recent study from the University of Missouri found. Beyond the worries about repaying debt, one reason for poor health may be that people with high debt have little money left to pay for resources that protect their health, the study said.

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If you have an issue with overspending, you may want to consider using a debit card for all purchases (and have your monthly bills debited from your checking account). Another powerful solution is to use cash. Take out only what you need for the month and when it is gone, you are done spending. If budgeting is a challenge, you may want to use a service like Mint or YNAB. These tools help you track and organize your monthly expenses so that you can prioritize savings goals.

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