There are several ways you can spend money, and it is necessary that you understand the advantages and disadvantages of each. It costs nothing but a bit of time to learn good financial habits, and ignorance simply exposes you to unnecessary risk.

All of you will soon, if you don’t already, have access to four ways to spend money: cash, checks, credit cards, and debit cards. None of them are strictly superior to the others. Each one has times and places when it is probably the best to use. Our goal is to understand when to use each and why.

Cash – for when they don’t take anything else

How it works: Notice on a dollar bill the statement: “This note is legal tender for all debts, public and private.” You may not be used to thinking of it this way, but whenever you buy something, whether a good or service, you owe a debt to whomever provided it. Cash is a medium that the government declares capable of satisfying such debts. If you give cash to whomever you owe a debt, the debt is immediately resolved.

Advantages:

• Can use anywhere
• Immediately satisfies debts
• Impossible to overspend

Disadvantages:

• Can be stolen
• Have to have enough with you
• Inconvenience of handling and making change

When to use: Always have a small amount of cash on you. It’s useful for small purchases and emergency situations.
Cash is great in that everybody accepts it. The problem is that you have to have the cash with you to use it, and always having lots of cash with you is a bad idea. The problems of needing to have the right amount with you and the possibility of theft are why the other methods of payment were invented.

Checks – for sending money to others

How it works: In order to write a check you must have deposited money into a checking account. A check is an order for your bank to transfer money from your account to someone else’s account to satisfy a debt. This transfer process takes some time, and if there are not enough funds in your account then the check “bounces.” Bouncing a check will subject you to fees, and you will still have to settle the original debt. Since the check itself does not fulfill a debt, anyone accepting a check is taking a small risk.

Advantages:

• Theft-resistant: can only be cashed by the person the check is written to

Disadvantages:

• Slow to process
• Businesses are taking a risk due to delayed payment
• Not accepted in most transactions (because of these inconveniences to businesses)
• Possible identity theft

When to use: Checks are a bad substitute for cash in making small purchases, since many retail and service businesses don’t accept them. Checks are best for paying bills, since this can be done from home and companies billing you are usually willing to wait until a check clears. This is especially true of regular expenses such as rent, electricity, or cable. These companies are not worried about getting paid since they can just stop your service if the check doesn’t clear. Checks solve the problem of sending money to others without the danger of it being stolen. They work very well for this, but their uses are limited. Checks are not really intended to be a general cash replacement in the way that credit and debit cards are.

Credit Cards – A replacement for cash

How it works: When you use a credit card, the credit card company takes on the debt and pays the merchant itself. In essence a credit card company is giving you a small, short-term loan each time you use the card. Periodically (usually monthly), you pay back the credit card company for the amount you spent. Most credit card companies allow you to pay back less than the full amount you owe and pay the rest later, but they charge interest on such a “balance” that you decide to pay later. In practical terms, the credit card company is offering you two types of loans. On purchases that you charge to the credit card and pay back at the first opportunity, you are taking a series of small low- or zero-cost loans with a limited amount of time to pay back. Any money that you leave as a balance on the credit card account from month to month is a higher cost loan that is flexible in how long you take to pay back.

Advantages:

• Theft-resistant: if stolen, the card can be canceled with little or no loss
• More convenient than cash
• Allows you to carry a balance
• Easy to track your transactions
• Builds credit rating if used responsibly

Disadvantages:

• Possible identity theft
• You must pay interest if you carry a balance
• Harder to keep track of how much you’re spending
• Damages credit rating if used poorly

When to use: Any time you could use cash. But make sure it’s also a time when you would use cash! Using a credit card is still spending money. If used properly, a credit card is a good way to make purchases. Credit cards can protect you from simple theft of the card, but require some effort on your part to keep track of your credit card statements and be wary of identity theft. Credit cards also demand a level of maturity and financial responsibility, since they let you spend more money than you have. This ability can get you in a lot of trouble if you get too far in debt. Using a card can make spending a little too easy, so never forget that you really are spending money each time you use it. See our section on Credit vs. Debit for a more detailed discussion.

Debit Cards – A way to replace cash with checks?

How it works: Debit cards are also widely known as check cards, and for good reason. Each time you use a debit card, money is transferred out of your checking account. While this makes it practical to leave your money in a bank account and not have to carry cash, a debit card offers little in the way of protection for your money. A debit card may be more convenient than cash, but despite a superficial resemblance to a credit card, it does not share most of the credit card’s security features.

Advantages:

• Convenient for most transactions
• Easy to track your transactions
• Easy to obtain regardless of credit rating

Disadvantages:

• Little theft-protection
• Hard to keep track of how much you’re spending

When to use: As with a credit card, any time you could use cash. But make sure it’s also a time when you would use cash! Using a debit card is still spending money. Debit cards are growing more and more common, and it’s easy to see why. They’re easier to obtain than a credit card, since credit card companies would prefer to know how trustworthy you are before giving you loans, and they appear to function similarly to credit cards in most situations. Do not be fooled, however, since this similarity is only from the consumer’s point of view. Debit cards are directly linked to your checking account, so if a thief spends money with it, there isn’t much you can do about it. Also, as with a credit card, using a card can make spending a little too easy, so never forget that you really are spending money each time you use it. See our section on Credit vs. Debit for a more detailed discussion.