Why People Underrate Psychology When Using Credit Cards

I was a having a spirited discussion with a personal finance blogger the other day regarding credit cards and the “rewards”/ cash back bonuses one can earn by using them. I was in agreement with the blogger, if used correctly credit cards can indeed be used to accelerate your business enterprise and give you extra money on items that are deemed “recurring” in nature. The problem with that last sentence is we are overrating human discipline and its complexities.

Case in point, research suggests that credit cards prompt overspending, with people often overspending for the same product that they could have paid cash for. This so called “credit card premium” helps reduce the pain of parting with our money and may reinforce bad spending habits. Being aware of the biasing effects of credit is more important than what mere numbers would suggest. This post aims to share the mindset I use when thinking about particular spending categories.

Business Spending

If you are a business owner, credit  is usually treated differently because purchases are driven for enterprise building purposes. If you are spending for client acquisition or the purchase has a potential return on investment component (building a website for instance) credit is being used to create value. Taking into account the tax considerations, business related budgeting is very different than most personal budgets.

Example: A trip to San Diego for business is not the same as a trip to San Diego to go yachting with your spouse or significant other.

Structuring your Personal Expenses

Structuring your personal expenses into variable and fixed costs is a worthwhile exercise. A fixed cost is defined  as an expense that does not change as a function of the activity within a relative period, while a variable expense is an expense that fluctuates according to your spending. Once this exercise is completed  I try to put most of my fixed expenses, that are recurring and necessary in nature on a credit card. A big assumption with fixed costs is not only the recurring and predictable nature of the expense, but that you are setting up fixed costs that are reasonable to your budgetary constraints.

Examples of good candidates would be your utilities, and any insurance based payments you may have.

Why Variable Expenses on a Credit Card Can Be Hazardous

This is the bucket where most people destroy themselves. Credit card expenditures on eating out, drinking or shopping are the usual culprits. For most people I would avoid using your credit card in these instances all together and I would instead use a debit card to make these purchases.

Setting up Proper Barriers

Creating a system for your money is very important and most people do not have one. One thing you can do is automate your payroll into a separate bank account just for your eating out money for example. With doing this the debit card has a set dollar amount, which if exceeded will be declined when you try to make excessive purchases.

 

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