Use credit cards with care

You could end up spending more through a card than you would with cash

.MUMBAI: Have you ever wondered why it is easier to spend money using a credit or a debit card, than spend actual cash? Why is the plastic money much easier to spend?

The answer lies in a concept called mental accounting, a term coined by Richard Thaller, a pioneer of behavioural economics.

Thaller defined it as “the  inclination to categorise and treat money differently, depending on where it comes from, where it is kept and how it is  spent.”

As Gary Belsky and Thomas Gilovich point out in their book, Why Smart People Make Big Money Mistakes and How to Correct Them, “In fact, credit cards and other types of revolving loans are almost by definition mental accounts, and dangerous ones at that. Credit card dollars are cheapened because there is seemingly no loss at the moment during the purchase, at least on a visceral level. Think of it this way: If you have $100 cash in your pocket and you pay $50 for a toaster, you experience the  purchase as cutting your pocket money in half. If you charge that toaster though, you don’t experience the same loss of  buying power that your wallet of $50 brings.”

In other words, individuals feel more pain when they spend cash to buy things.
“In fact, the money we charge on plastic is devalued because it seems as if we’re not actually spending anything when we use cards. Sort of like Monopoly money,”  Belsky and Gilovich add.

What one forgets here is that the money spent through a credit card is more expensive, considering a failure to repay the amount during the credit period would mean extremely high interest payments.

Also, since individuals cannot see the money they are spending, they end up spending more. As Belky and Gilovich point out, “But you may be surprised to learn that by using credit cards, you not only increase your chances of spending to begin with, you also increase the likelihood that you will pay more when you spend than you would if you were paying cash.”

So, the next time you are tempted to go on a shopping binge and don’t have enough money, leave that credit card at home.

k_vivek@dnaindia.net