In working with clients on their budgets, we see that it is common practice for people to live off of their credit cards. No, not by spending beyond their means and piling up unsecured debt, but rather by swiping their credit card for every expense no matter how big or small, paying the balance off in full each month, and reaping the rewards in terms of points, miles, or cash-back bonuses. As long as you are disciplined in paying off the balance in full each month, this widespread practice makes sense in terms of the convenience and the rewards, but in our budget work, we have identified a drawback that often goes unnoticed.
When you visit a casino and you wish to try your luck in a game of chance, you first have to exchange your dollars for chips or your coins for tokens. There are a few reasons why casinos do this, but one key reason is that it turns your money into an abstraction. Casinos know you will have an easier time betting a black chip made of clay than a green bill with Benjamin Franklin on it. Technically, they’re both worth $100, but the chip is a representation of money, not actual money itself. As a result, whether you realize it or not, you don’t have the same emotional attachment to that chip as you do that greenback.
The same thing applies when using your credit card for regular transactions. Actual dollars are not exchanged, so the plastic in your wallet is also an abstraction of money, which makes it easier for you to spend than it would be if you are dealing with actual dollar bills and coins. And in one aspect it is easier to spend with your credit cards than it is with your casino chips: at least the casino takes your chips at the time of your loss whereas the bill for your credit card spending doesn’t come due until up to 30 days later.
To combat this potential problem, we suggest dividing your budget into two categories—discretionary and non-discretionary expenses. The non-discretionary items represent expenses that you have to pay on a regular basis—the mortgage, tuition, food for the house, gas for the car, utilities, etc. There is no thinking or impulse with these expenses, so it’s fine to continue to use your credit card for the convenience and the rewards (as long as you’re paying off your balance in full each month).
As for the discretionary items, these are expenses like clothes, entertainment, and dining out. To cover these costs, set aside a certain amount in cash each month. When that amount is depleted, you have to wait until next month to replace your discretionary cash coffer. This process institutes a deeper discipline with your discretionary purchases because it sets limits (just as you would at a casino) and produces a closer attachment between you and the money you are spending.