Q: what do you think about not spending anything on credit cards? everyone else is in trouble so why not use cash only!”

For the past few weeks I couldn’t get this statement off my mind. It’s one thing to have a strong position . It’s quite another to insult those who follow a perfectly legitimate and arguably superior system of financial management.

To resolve this issue, or at least let the blog-reading community decide for themselves, I challenge Ramit to a good-spirited showdown: Credit Cards vs. Cash. Ramit can present the credit-card arguments and I’ll present the cash/debit arguments. The readers on each side can also chime in. I read a similar showdown about productivity a while back and thought it was useful.

Please leave a comment and let us know what questions or views do you have about credit cards vs. cash? What questions would you want to see addressed if a showdown takes place?

If Ramit accepts we’ll decide the terms, time, and format. Let’s have Ramit express his spirited feelings in a more articulate and useful way.

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One of the first steps of sound financial management is tracking your spending. Once you track your spending and are able to see where the money goes, it’s easier to attempt to control your spending. How can you control something when you have no idea what it is you need to control? The bottom line is, tracking your spending goes hand in hand with controlling it.

Tracking, but no control

However, despite the wonderful resources available to track your spending, it still seems to be out of control for most people. Money management programs such as Quicken and MS Money are great tools to help you track your spending. In fact, electronic methods of payment such as debit and credit cards are also great at helping you track your finances. Every transaction can be easily downloaded or viewed. But if these tools are so wonderful at tracking expenses, why are most people’s finances out of control?

Despite the ease of tracking spending using credit cards, credit card debt is rampant. Americans carry, on average, $5,800 in credit card debt from month to month (www.cardweb.com). The Federal Reserve states that, on average, the typical credit card purchase is 112% higher than if using cash. It seems the convenience of using credit cards makes it a little too easy to spend money.

Control, but no tracking

On the other side of the fence are cash and check transactions. While spending with paper currency gives you a higher degree of control (especially cash), it’s a pain to track. Nobody enjoys balancing their checkbook, compulsively saving receipts, or entering expenses into a spending notebook.

The secret to tracking and controlling your spending effortlessly

So what’s the solution that will allow you to track what you spend and maintain total control over your spending? The answer is CASH.

“What? Cash? I thought you just told me that cash is a pain to track? Plus I LOVE the convenience of my credit card.”

Ok, before you blow me off, just hold on for one more minute. I’m not saying that ALL spending needs to be cash, just the categories that are out of control. As my wife and I worked out our financial plan we realized there was a very small set of categories that were out of control. These will vary from person to person but our hard-to-control categories were:

o Grocery

o Household

o Eat Out

o Clothing

o Personal

This is by no means an exhaustive list. Figure out your own hard-to-control categories and you’ll know which ones you should use cash for. Your other expenses will be dealt with separately and I’ll explain how you should manage them in another post. As a first step, we just want to get these categories under control.

So, here are the steps to tracking and controlling your spending effortlessly. And the great news is you can start it TODAY!

1) Identify which categories are problematic (you tend to overspend).

2) Commit to not buying ANYTHING in that category with a credit card.

3) Go to the bank and withdraw the amount you think you will or should spend on the category UNTIL THE END OF THE MONTH.

4) Put that money in an envelope and write down the date, how much you took out, and the category. To simplify things you can just write this information on the envelope, but feel free to record it in any trusted place.

That’s it! Financial peace has just been achieved. Well, not quite. One of two things will happen. 1) You won’t spend all the cash and will have money left over at the end of the month or 2) you will spend all the cash before the end of the month and need more.

If the first scenario happens, great! Keep the money in the envelope and just add to it at the beginning of the next month. On the other hand, if you spend all the money and need more, don’t stress! Just go withdraw the additional cash that you think you need for the rest of the month and record it on the envelope.

Either way at the end of the month you will now have an idea of how much is needed for that category and will be able to estimate next month’s amount more accurately. Don’t worry about getting it exactly right for now. It will typically take doing this for about 3 months until you have a really accurate estimate.

Even then, these problematic categories are problems because they tend to fluctuate so much. If you’re tight financially, this is a great time to see if what you think you’re spending is in touch with reality. It’s also a perfect way to control your spending by deciding before hand how much you really think you should spend on that category. Just like they always taught me in Sunday School, it’s important to decide ahead of time how you’re going to respond in tough situations. Similarly, you should decide how much you want to spend BEFORE you’re standing the grocery aisle trying to justify purchasing that extra bag of cookies.

Now, if you already track your spending electronically (e.g. in Quicken or online) you should be able to make very accurate estimates from the get go. If that’s the case, great! Your just one step ahead and this process will be a little easier. Even so, you may have trouble tracking some spending such as single transactions that cover multiple categories. Wal-Mart is one of the biggest offenders. I can’t tell you how many times, in the name of tracking every penny, we agonized over a Wal-Mart receipt trying to determine which portion was grocery, household, medical, etc.

Goals of the process

While going through this process there are a few goals you should work towards.

1) Figure out how much you really spend.

2) Make your spending habits more conscious.

3) Control your spending.

Figure out how much you spend (get in touch with reality)

One of the huge benefits of going through this process is that over a few months you will get a very accurate idea of what you spend with very little effort. One thing many of you will have noticed is that you won’t have a perfect “to the penny” record of what you spend. Rather, you will just know the total amount you spent for the month. Enjoy this fact. Enjoy the freedom, the need to not have to calculate every single transaction. You just open the envelope and if there’s money you can spend it.

At the end of the month it will be very clear if you didn’t budget enough; your envelope will be empty and you will feel like you just didn’t have quite enough.

The analytical crowd may cringe at not tracking every cent but let me ask you, what’s the benefit of tracking every penny versus the total amount? There are very few situations in which it really matters. These days, most of the expenses will be at Wal-mart anyway. The goal is really just to get an overall amount that you tend to spend. By not tracking every penny we will still have an accurate budget but it will be accurate on a summary level rather than a detailed level. As we address your non-cash expenses you’ll see that you WILL know how much you spend every month to the penny but you won’t necessarily have a record of WHERE you spend your cash expenses.

Now I can still see the analytical people out there still cringing. If you REALLY want to track every single purchase, go ahead. If you really have no idea where you’re spending your money, it would be very useful to see where it’s going. If you currently use credit cards you can just look at your statement. Otherwise, feel free to keep receipts and enter them into a notebook or Quicken. In fact, my wife and I had used Quicken faithfully for years so we already knew where we spent our money. Most people have a pretty good sense where the money goes. They just need a way to control the outflow.

Make your spending habits more conscious

Really the goal for now really isn’t to reduce your spending, although for most people that will be a natural result. Instead, you just need to make your spending more conscious. Don’t just pull out plastic and not worry whether or not you have the money.

One great thing about cash is that it’s very tangible. Most people have a visceral reaction to spending cold hard cash. It can be hard to see those Georges sniff, Hamiltons (baby) sniff-sniff, and Franklins triple-sniff fly out the window. Plus it’s a very visual medium. An empty envelope definitely sends a signal that credit cards simply can’t duplicate. I can’t tell you how many times I told myself I’d pay with a credit card and just worry about where the money would come from later (I only did this in a previous life, of course).

Control your spending

Notice that I said “control” your spending, not “reduce” your spending. The main point right now is to simply control what you spend. Decide ahead of time how much you are going to take out; how much you think is reasonable for that category. By making that conscious decision you have already increased your chances tremendously that you won’t overspend. If you run out, you will have to make a very conscious decision whether or not to withdraw more. True, it’s not as convenient to withdraw more many than just using a credit card. And that’s exactly why you won’t spend the 112% more that I mentioned earlier.

Credit cards in their place

By promoting a cash-based spending system, I’m not saying credit cards are bad or evil. I used credit cards for years and paid off the balance each month. I still carry a credit card with me for emergencies and reimbursable business expenses. If fact, I actually work for a company that provides merchant accounts (the ability to accept credit cards) to small businesses.

However, the very statistics I use to promote credit card acceptance at work proved to be the reason I decided to stop using them for most purchases. At our company we constantly pitch that customers spend 2-3 times more when paying with a credit card versus cash or check. While this is a great way for a small business to grow their sales, it’s also happens to be a great way for you to grow your expenses. Credit cards are like that kid telling your first grade son potty jokes; they just aren’t a good influence on your personal finances.

What about debit cards?

Debit cards play an important role in managing your finances and will be discussed in later posts. Debit cards combine convenience with a more responsible approach to spending; the money has to be in your account or you can’t spend it. They are great for expenses that don’t vary much. In fact, we used to pay for gas with cash but after a while we realized that we didn’t really reduce our spending by paying with cash and it was a LOT more inconvenient having to walk into the convenience store. The bottom line was that I didn’t drive to work less because I was paying with cash so it made sense to use the debit card.

Give cash a “30 day trial”

So here’s the challenge. Try this today! Try it for a month. You’ll be surprised at the insights you gain. Sure it’s a little more inconvenient but one of the ultimate benefits will be stress-free financial control and you probably wouldn’t be reading this if that weren’t attractive to you. I encourage you to take a look at Steve Pavlina’s article on the 30 day trial concept. It would be a great approach to get your finances kick started.

Please post your comments and experiences as you try this out. If you happen to already use cash, let us know how you manage it physically (via envelopes or some other way).

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