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I was talking to a colleague at work a few weeks ago, and he was complaining that he would never get out of debt. He felt flooded with his pesky student loans, exorbitant rent, and monthly car payment for his luxury car.
At the end of each month, he feels depressed because his whole paycheck seems to be distributed between all the bills with nothing really leftover. And he makes a six figure salary. He lamented saying he would never be able to afford a home, and the thought of retirement, so distant and unattainable.
I wish this was the first time that I had a conversation like this with someone. But, in the years of facilitated Dave Ramsey’s Financial Peace course at my church, this conversation is all too common.
First Things First: Budget
The first thing that I asked him was if he had a budget. When he responded with “No”, I encouraged him to set up a Personal Capital account so that he could start tracking his spending.
After a couple of days, he came back with his account set up and amazed at his spending habits. Turns out he did have extra money each month, but it was going towards leisure activities such as eating at restaurants. Like most people I meet, he underestimated how much he actually spends.
Then, I brought up creating a budget with him again. I explained that it would allow him to achieve his goals of wanting to own a home and prepare for retirement. Not surprisingly, he was hesitant at first. He gave all the usual excuses: “a budget is too hard”, “I don’t want to restrict myself”, and on and on and on.
I usually smile and nod my head in agreement. Creating a budget can be daunting. But then I say, “If you’re happy with the situation that you’re in, keep it up. If you want to alter your trajectory, then you have to make some changes.”
I don’t mean that once you create a budget that you must live off ramen and deprive yourself completely. As discussed earlier, I am all about value spending and enjoying your life within your means while saving for the future.
After my colleague completed his budget, we discussed trying out the envelope system. This system was first introduced to me by the Financial Peace course I mentioned earlier. I personally think it’s an incredibly useful method for those that are in debt.
For those that are not familiar with the envelope system, this method encourages one to take out cash each month and place it into various spending envelopes allocated towards different areas of spending. The individual then pays with the cash from the appropriate spending envelope.
Please note that some expenses you probably wouldn’t be able to pay in cash, such as mortgage, electric, gas, water, etc. The envelope system, however, is excellent when it comes to discretionary spending like eating out, buying clothes, and general entertainment.
Why It Works
The reason why the cash system is so effective is because studies have shown that when a consumer spends cash, they are more likely to spend less with cash than with a credit card. A credit card swipe is much easier than fishing out coins and bills. Plus, with cash, one’s spending limit is much more tangible and real. There is nothing more restrictive than not having enough cash to pay for something.
If you want to get technical, the envelope system revolves around the loss aversion theory. People prefer to avoid losses over acquiring equivalent gains. Some studies have even show that losses are twice as powerful psychologically as received gains.
It’s no wonder that businesses don’t make a fuss over credit card usage. Anything to get you to buy more is always beneficial for companies.
Cash Is King
Some believe we are moving to a cashless society. When I was doing research, I thought I was going to find a lot of data supporting this theory as well. Do you know what I actually found? I was wrong. 46% of the U.S. population pays non-recurring bills with cash.
Do you realize that most German consumers exclusively use cash to pay for things? 82% of them to be precise! Some researchers hypothesize this is because Germans value their privacy and don’t want merchants to monitor their credit card transactions.
While researching, I also found that Germans hate debt. This is why only 35% of Germans actually own their home versus rent. This totally surprised me, but when given the nature of the German culture, hyperinflation in the 1920s, and World War II in the 1940s, I get why cash is king to them.
Negatives of Cash
Now, I’d be remiss if I didn’t talk about the three major downsides when it comes to paying everything with cash.
Manual Entree into Personal Capital
You’d have to input all of your expenses into Personal Capital or your preferred budget software. This can be a hassle if you are forgetful or just find it tedious. However, if you get into the habit of collecting your receipts, taking 15 minutes on a weekend to input really shouldn’t be that bad.
Carrying Large Amounts of Cash
Carrying around large amounts of cash makes some people nervous. I totally get that. One thing to alleviate that is to divide your withdrawals into amounts that you make you feel comfortable for the envelope system. So instead of withdrawing everything once a month, you could break it down into biweekly or weekly withdrawals.
No Cash Rewards
You wouldn’t be able to earn any cash rewards like those from your credit card or gain any sort of points when you make purchases. For people that use their points to travel, this could definitely be a negative aspect.
With that said, studies done by the US Consumer Financial Protection Bureau have shown that debt decreased by about 5% for groups of people who primarily paid cash for purchases over a six month period.
Have you ever tried the cash system? What was your experience? Share your thoughts below.