Now, consider the same situation, but change the method of payment. Before going to the store, you go to your bank and withdraw the necessary cash. You watch as the teller counts out several hundred dollars in $20 bills. With a plump envelope in your jacket pocket, you go to the same electronics store and buy the same TV. Now, you watch as the cashier carefully counts out that wad of cash. Somehow, this purchase is more difficult. This phenomenon is known as the “pain of paying.”
Credit Cards Delay the Pain
From a strictly objective point of view, the two transactions described above are roughly the same. You spent the same amount of money and ended up with the same product. However, the cash transaction may feel more difficult, because the payment feels much more “real” when the physical cash is being transferred.
If you detach yourself from the situation, you’ll realize that credit cards are not evil. From an emotional standpoint, though, they do make a difference. This is because credit cards are able to offer you that instant gratification (a new TV), while delaying the pain of paying. You don’t have to pay for the TV until your credit card bill comes at the end of the month. There is more of a detachment between the purchase transaction and the payment transaction.
The Human Factor
As human beings, we have a somewhat twisted perception when it comes to money and payment. With a credit card, you get the benefit of a delayed payment, plus the possibility of bonus rewards and built-in record-keeping. However, for people who struggle to maintain a budget, a credit card can be a challenging temptation that leads down a rather unfortunate road.
A popular piece of advice given to people struggling with debt is to switch to a cash-only existence. This magnifies the pain of paying on every transaction, hopefully reminding this person that with every latte, every indulgence, and every bill, money is changing hands in a very real way. You start to recognize the opportunity cost of the situation.
Taking it even further, you can divide up your monthly budget into cash jars. Each jar represents a certain category of expenses, like food or transportation. When you need money for lunch, you take the cash out of the food jar. This is a technique that Gail Vaz-Oxlade typically utilizes with her clients on Til Debt Do Us Part. By doing so, the pain of paying is severely amplified, because you can see and feel the amount of money in each jar shrinking each time you take out some cash.
Making More Money Doesn’t Solve the Problem
If I have budget issues, all I have to do is make more money, right? That way, I can cover my expenses and have some play money to spare? Unfortunately, going back to the human element, that doesn’t really work. More often than not, when you make more money, you tend to spend more money too. If you mismanaged an income of $30,000, you’re likely going to mismanage an income of $300,000 too.
We once came from a society where each family unit was self-sufficient. Then, we moved to a bartering society, where one good with directly traded for another. That made the opportunity cost real; by getting that one goat, I directly lost three chickens. Then, the advent of cash made these transactions easier, since money could work as a medium with which to trade with anything and with anyone. But it made money more abstract. By intensifying the pain of paying and returning to a barter-style mentality, money can start to feel real again.
Check out the video below from Big Think, one of my new favorite YouTube channels. They’ve got Michio Kaku talking physics, Penn Jilette talking atheism, Ricky Gervais talking comedy and, in this case, Professor of Behavioral Economics Dan Ariely talking money.