One of the insidious things about credit card debt is how quickly it adds up and how it can appear without warning. This is because cumulative cost neglect plays a big role in getting you to a point where you end up with crushing amounts of debt. People who have cumulative cost neglect mind-frame do not think of their daily purchases adding up. Instead they view each transaction separately.
“Even if boundedly rational, consumers might well hesitate before borrowing $20,000 at a high rate of interest. But if a long series of much smaller purchases has that same effect, the cost might well be less visible. A distinctive form of bounded rationality stems from neglect of the aggregate effect of large numbers of relatively small borrowing choices. Call this ‘cumulative cost neglect.’”
—Cass Sunstein, Boundedly Rational Borrowing
If you had a cumulative cost neglect mind-frame, then instead of thinking of how much interest you will pay on the $5 you spent on coffee plus the $35 you spent on shoes plus the $25 you spent on dinner at a restaurant (total: $65), you think only of the individual purchase made at the time. The $5 purchase is especially insidious. You think: “It’s only $5. No big deal.” But if you spend that every weekday on your way to work, that’s $25 a week and $100 a month. Before you know it, you’ve put $1,200 on your credit card—for coffee—over the course of the year. And if you carry a balance, you are paying interest on it.
Daily purchases can add up. But if you practice cumulative cost neglect, you probably won’t notice until you are rather far into credit card debt. And this is how the companies want it. They want you to use your card for small, daily purchases, which will make you accumulate debt faster. Then you will be forced to pay the credit card companies interest. But you can beat them at their game. The key is changing the way you use your credit cards. First, only use your card for large purchases. This requires you to really think about whether you actually need or really want the item. Think about whether you will be carrying a balance and determine how much the interest is going to cost you.
Next, carry cash for small purchases. Paying in cash can force you to decide whether you really need those small indulgences. Also, you can keep the change from your cash purchases in a jar at home. At the end of every month, add up the money, roll the coins, and take it to your bank to make an extra deposit. Or you can use it to treat yourself.
The important thing is to avoid cumulative cost neglect and to consider your daily purchases. Only when you change your mindset can you avoid credit card debt.
Next: Why We Get in Debt, Part 4: Procrastination
Previous: Why We Get in Debt, Part 2: Lack of Self-control
All posts in this series:
Why We Get in Debt, Part 1: Behavioral Economics and 5 Types of Apathy
Why We Get in Debt, Part 2: Lack of Self-control
Why We Get in Debt, Part 3: Cumulative Cost Neglect
Why We Get in Debt, Part 4: Procrastination
Why We Get in Debt, Part 5: Unrealistic Optimism
Why We Get in Debt, Part 6: Keeping Up with the Joneses
Why We Get in Debt, Part 7: Know Yourself and Your Limitations
