The Illusion of Credit Card Rewards Programs

money_mythCredit card rewards programs are popular with card users. Many personal finance sites and bloggers devote considerable attention to evaluating the merits of different credit cards that reward users based on spending levels. In the case of some bloggers, those evaluations rise to the level of outright promotion because of affiliate advertising relationships between the blogger and card issuers. I am a contrarian and believe that the awards benefits of these programs are, on balance, an illusion. Let me explain this hard truth.

Rewards as a Credit Card Justification

I occasionally will drop a comment on another blog, questioning the time and energy that is spent studying, comparing, and most of all using rewards credit cards. More often than not, my comment is met with a dismissive response from other readers – and even the blogger – in which they proudly announce that credit cards are simply a tool that they use to reward themselves through spending activities. It costs them nothing, they say, because card balances are always paid in full at the end of each month. They argue that they actually improve their financial position by using a rewards card.

I’ve heard this rationalization so many times that I’ve mostly given up even discussing credit card usage on other blogs. That doesn’t mean, however, that I think that the justifiers are right. They just choose to ignore the science of spending.

Increased Spending Trumps the Card Rewards

I still believe that the “rewards” from rewards cards programs are mostly a myth. I also contend that the data supports my belief. The reason is quite simple and basic: People who purchase with credit cards spend more than they would if they used cash instead. The increased spending outweighs the rewards benefit.

There are several studies that show a spending differential between cash and card users. The most recent study I could find on this subject was published in 2008 in the Journal of Experimental Psychology. Here is one of the relevant conclusions summarized by the authors:

Consistent with previous research, both Studies 1 and 2 demonstrated that people are willing to spend (or pay) more when they use a credit card than when using cash. Importantly, the results of both studies suggest that the underlying reason for the differences in spending is, at least, partly due to differences in the pain of paying.

This same study also compared spending tendencies between cash and other forms of payment using plastic, e.g., debit cards and gift cards. Remarkably, the presence of credit card branding on the debit or gift card also triggered an increased tendency to spend:

Thus, even though consumers were not explicitly informed which payment mode they would be using, the mere presence of a credit card logo increased the price that they were willing to pay.

Now we know why banks and merchants like the VISA logo on debit cards and cash value cards.

A typical rewards credit card will rebate the user anywhere from 1% to 3% of a purchase, and in some cases as much as 5%. Even without doing the math,  it is easy to see that these minimal cash rewards are quickly overcome by the increased tendency to spend compared to cash. Paying with cash would provide a greater financial “reward” to the buyer than would a rewards credit card, because the buyer would not be spending as much. The net “rewards” from rewards cards are not only illusory, they are negative.

Of course, proponents of rewards cards who are reading this are thinking that this science does not apply to them. They believe that they are sophisticated card users with an uncanny ability to maintain a constant spending level, whether using cash or credit. This may be the case for some but the argument in general is undermined by the very nature of human behavior.

Psychologists tell us that we don’t always understand what we do or why we do it. (Thus the need for psychotherapy in extreme cases.) We are not necessarily aware if or when we are spending more as a function of how we are paying. As the study authors tell us, there are pyschological factors in play, including a desire to experience less pain in our daily lives:

The outflow of money is very vivid when individuals use legal tender such as cash, making it painful to part with. In contrast, any payment mode that makes the outflow of money less vivid, and thus less painful, reduces the psychological barrier to spend.

In the case of credit cards, there are two additional reasons that the pain of paying is dulled. First, the payment is temporally separated from the consumption. Second, credit cards allow mixing of purchases where several purchases are combined into one payment such that a single payment is not attributable to a specific consumption.

That’s not too hard to understand, is it? If you still don’t believe it, put your cards away for a few months and compare your spending levels. Report back here when you have finished.

Concluding Thoughts on Rewards Cards

I harbor no illusions myself that a Mr. ToughMoneyLove rant – or actual science  – will cause rewards cards fanatics to change their minds. Some habits – and particularly the bad ones – are hard to break. I also understand that certain purchases are difficult if not impossible to complete using cash. But I maintain my right to call BS on anyone who argues that a rewards credit card is a legitimate tool for enhancing net worth.

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28 Responses to “The Illusion of Credit Card Rewards Programs”
  1. HomeFree says:

    TML I agrre with you about rewards cards. The “rewards” from cards are almost always paid for by the card user through higher consumption. We have a “rewards” card but typically only charge three monthly expenses that are essentially fixed costs. We keep the card for convenience when we travel.

    In January we transitioned to cash only and we agree that there IS AN EMOTIONAL IMPACT when we make a purchase. The emotional impact combined with a budget for various categories has made a huge difference in managing our spending!

    This has contributed to our ability to reach 16% of goal to pay off our home “HomeFree” since January 1st!

    I appreciate all who help us stay focused on our financial goals!

  2. TMN says:

    I don’t buy it, and here’s why:

    1) I have a budget which I stick to pretty strictly. I’ve evaluated my cash flow in a process that’s emotionally separate from any particular purchase, and I use that to control my spending. Now, maybe I would spend less than my budget if I used cash, but that brings me to…

    2) Spending on credit cards and using Mint for finance tracking makes sticking to the budget MUCH easier than if I were to use cash. Cash disappears in odd places, and personally I can never remember where half of it went, which makes it damn hard to stay on a budget. Yes, that’s something that could be overcome by saving every receipt, sitting down nightly and entering values in a spreadsheet, and some other tedious stuff that I’m honestly never going to do. Having it done for me automatically is hugely valuable, because it gives me nearly instant feedback on how my habits are fitting into the budget that I’ve set for myself.

    3) Apart from the budget issue, there’s a convenience factor involved. I wouldn’t feel safe walking around with $500 in my wallet. My personal comfort level tops out at around $160. Which means that I have to track down an ATM two or three times a week, and that takes time. If I can’t find one from my specific bank then I get to pay a fee on the money I take out, which with my limits of carrying cash is at least 1% off the top, and usually closer to 2%.

    4) To be able to withdraw that cash on demand I have to keep it in a checking account, which is almost always low or zero interest. Using credit cards, I can leave that money in high-yield savings over the month instead.

    The benefits of 3 and 4 are monetary and calculable, and combined with the incentives program on my card they do a lot to help offset any spending increase that comes from the psychological effects you mention. After those are all accounted for it may still be negative, but the fact that I can budget without devoting half an hour a day to manually entering receipts is well worth some extra dollars spent here or there, especially since the better I get at it, the more it will tend to stifle that effect.

  3. PT Money says:

    In my case, I only use my card for travel expenses related to my job, for which I am fully reimbursed. I have to spend this money. My job requires me to. There’s no phychology behind it. So, in my case, it truly is a win. I realize I’m in the minority though with my situation.

    If I were to extend the use of my card to personal expenses, I’d try and spend it on my fixed recurring expenses (utilities, services, fuel).

    I definitely see your point for expenses like food, personal trips, and household goods. That’s where the phychology comes into play. Good post, TML.

  4. TML, I’m in complete agreement. I get a headache looking at all the “rewards” options and only use my card for automatic bill payments and online purchases, which are very much planned and researched.

    I get 1% cashback, my card is with Citibank, and I pay my balance in full every month, blah blah. I’m only mentioning all this because when Citi started screwing around with bailout funds and jacking everyone’s interest rates despite very public promises to the contrary (mine was in the first wave), it gave me GREAT pleasure to know that my 1% cashback was their profit from the vendor side of my transactions, and they were therefore essentially making NOTHING off me.

  5. Jen W says:

    I agree with you for the most part on this, yet I still continue to use my rewards card. The primary reason for that: convenience. I don’t like to carry a lot of cash on me and I would hate to have to be taking extra trips to the ATM to take out more cash.

    As far as increased spending with credit, I’m not going to try to argue that it doesn’t happen to me. I’d like to think that it doesn’t, but I suspect that it does. I often find myself walking away from the register after having paid by card and realizing that I don’t even know what the total was, which can be a very dangerous thing for someone on a tight budget (I am not). I like to think that this is somewhat offset by the care I take in selecting items and noticing their prices before they even go into my cart. However, I have no doubt that additional items (not on the list) may make it into the cart that I wouldn’t get if I had known that I only have x dollars to spend. That said, (and this is just my personal experience), I think only paying in cash would result for me in making more trips to the store, since I might be hesitant to purchase certain items I know I will need because I don’t happen to have the cash on me (this applies mostly to groceries). Note that I am differentiating here between having cash actually on my person versus having the funds in my account – I don’t keep a balance on my card. For me, some extra spending is worth having to take the time to make more trips to the store.

    Finally, as another commenter mentioned, I occasionally must pay for work-related travel that I will later be reimbursed for. Putting this on a rewards card is great because I will get 1-3% on expenses that could be potentially large (the occasional $1000 plane ticket to Europe) for example) while still getting back the money spent.

    So in a nutshell, I know I am probably spending more money with a rewards card. However, I use one anyway because I value the time that it saves me in trips to the ATM and potential extra trips to the store. Using a card with rewards helps, at least partially, to compensate for that extra “convenience” spending.

  6. Ms. Ferret says:

    I’m sure cash-only works for some people, but I’m not one of them. I used cash-only for years and found it more or less impossible to stick to a budget. When I have cash it tends to evaporate, because I know I can spend it without future accountability — sure, the money’s gone, but where did it go? Certainly not into that second pitcher of beer. Certainly I didn’t blow it all at the girly bath products store. Sure, I never spent more money than I had, but I never managed to save anything either, because the money just went _somewhere_.

    With a credit card, if I spend $100 at Ye Olde Embarrassing Widgets Emporium I have to look at that in Mint and tell myself “yes, I really did spend that much on embarrassing widgets last week.” If I use cash, at the end of the month the $100 is equally gone, but I can convince myself that I must have spent it on something useful and necessary. Credit cards, ironically, force me to maintain a certain amount of honesty regarding my spending.

  7. No Debt Plan says:

    So essentially people who want to use credit cards, but can’t are idiots?

    That’s what I take from this.

    I have a budget. We track it with Excel. We stick to it. It wouldn’t matter if we were paying cash, using a debit card, or using a credit card. We use credit. It makes paying bills a helluva lot easier, and we’re not going on wild spending sprees.

    I guess maybe my wife and I are an enigma, a blip in the matrix that shouldn’t exist, yet we do. And we’re nothing special. (And I’ve earned $400+/year for the last 3 years on top of sticking to our budget.)

  8. SJ says:

    It doesn’t apply to meee! I knowww it…. haha

    The only things I buy and put on my card is food. I spend both cash and credit on food. Also I track it on a google documents file… So easy to stick to fake budgets. (For me it’s retroactive, I see how much/what I spent on and alter spending afterwards heh)

    But honestly, I spend so little that I doubt I take much of a hit

    The other thing that I think everyone overlooks is the increased transaction costs for the vendor which they will obviously pass on to you. Does that cost exceed the rewards I am receiving? Prolly not lol… so I might as well try and counter-act that… (It kind of reminds me of a prisoner’s dilemma but ohwellz)

  9. Ian says:

    Re: Credit Card Reward Illusion
    Let’s not over think this issue. Credit cards are a “modern” convenience. Like a car it can get you where you want to go or it can “kill you” in a manner of speaking. Grown up people use both responsibly and no one gets hurt.
    I pay every possible household recurring bill that I would spend money on any way whether it be in the form of cash, bank debit, check etcetara with the same credit card for the last several years. They give me a “kick back” of $500-$600 a year. One of the recurring bills is from an isurance division of the same company that issued the card! They are in effect paying me to pay them. America…what a country!

  10. Gail says:

    I think all the responders are missing the central point of Mr TML’s article. The purpose of the article was NOT to argue against the use of credit cards per se, but only to point out that using these rewards cards is not a valid tool for wealth-building, even for people who pay off their balances each month (because the greater amount of money spent when you pay with a card compared to if you paid with cash outstrips the meager rewards gained). I too believed I was being a saavy consumer by using these cards until I read an article in Money magazine last year that discussed research on this topic…it really opened my eyes. I do believe there are solid reasons for paying with a credit card vs cash, but making extra money off the credit card companies is not one of them! Those who justify their CC purchases by pointing to these reward programs are kidding themselves.

  11. Ms. Ferret says:

    Regarding the reaction to your comments on other blogs — one thing to note is that the authors/readers of personal finance blogs are very likely to have different attitudes towards credit and money than the 114 college students who participated in the psych study mentioned above.

    Do 21-year-olds, with the poor impulse control of 21-year-olds, helplessly spend more money if they use credit cards vs. cash? Probably. Do people in general helplessly spend more money if they use credit cards vs. cash? Maybe. Do personal finance geeks who unit-price toilet paper, down to the square, helplessly spend more money if they use credit cards vs. cash? Probably not.

  12. Rob Bennett says:

    This reminds me of discussions of indexing.

    Some indexers say that no one can pick stocks effectively because most people cannot pick stocks effectively.

    Now some say that no one can obtain rewards from using credit cards without being enticed to spend more than they otherwise would.

    On average these claims are true. But no one living human being is an average. We are individuals.

    I believe that some people benefit from picking stocks. Not most. Some.

    I believe that some people benefit from rewards programs. Not most. Some.


  13. Ryan P Smith says:

    I agree with a lot of the comments here that using a credit card for budgeted expenses is fine, and the rewards are definitely a benefit of this.

    I think the article was aimed more at people who justifying taking on more debt than they can handle because they will get *miles*.

    Our cash back rewards usually take care of our Christmas spending, so it works for us.

  14. Anne says:

    I’ll speak up as someone who spends more with a credit card. I just do. I also tend to get stupidly motivated by earning reward points. It’s totally counter productive and so I’ve been trying to move myself over to cash only (or at least majority cash).

    I think this is just one of those things where genuine self awareness is needed. If you can show me, in real numbers, that your use your CC responsibly and are gaming the system for rewards then go you! Seriously, well done. I can show you in equally real numbers that I can’t do that reliably no matter how much I think I can. I think we’re both getting rewarded for taking a hard look at the situation. You get rewarded and I don’t stupidly overspend 😀

  15. MasterPo says:

    If I have to use a credit card I may as well use one that gives me some reward I can really use.

  16. Rick Beagle says:

    As I have stated previously, I use my card simply for travel expenses incurred as a result of my job. As another poster mentioned, I like the occasional “perk” from what is in essence a zero sum game for me.

    Rick Beagle

  17. kitty says:

    A few comments about the credit card studies.

    1. In most credit card studies, the data deals with averages. But “people spend more on average when they use credit cards” as “every single person who uses credit cards spends more”. The latter just does not follow from the former.

    “On the average people spend more …” means that if you take 100 people who use cards and 100 who don’t, the total amount of money spent by first group is higher. It doesn’t tell you anything about how many people in the first group spend more or how it correlates with carrying balance or paying in full.

    2. From the quick look at the cited article, the difference in spending between groups in experiments that specifically compares spending with credit card vs cash looks small. Over 50% of people who carry balances can easily account for this difference.

    3. The referenced studies involve a small number of people. They also select generally less mature and less responsible group – students.

    4. None of the studies appear to be the “golden standard” of studies i.e. randomized control studies involving a large number of people. In fact some of the studies rely on questionnaires. This type of studies is notoriously unreliable. You can look up history of hormone replacement therapy studies from the 90s as a reference.

    One study I’d love to see is the one that separates those that always pay their balances in full from those who carry a balance and sees how this correlates with spending in each of the groups.

    Personally, I find it hard to believe that for the majority of those of us who pay our balances in full every month “I am not spending real money” mentality can survive the first large credit card bill. There are many things in life for which you don’t pay right away. Yet how many of us set heating to 75F in winter or 72 in summer 24 hours a day? What is stopping us if not the thought of a large bill or an experience of seeing a large bill? Parting with a large amount at once is not pleasant.

    Yes, one may have emotional attachment to cash, I personally have “emotional attachment” to money in any shape or form it comes…. As to rewards and cash back – it’s a useful perk to those who don’t spend more, it’s useless for those who do. It’s not going to make you rich, but if you are using the card anyway and paying in full why not choose the one that gives you something back?

    @Ms Ferret, Rob Bennett – great points.

    @ – those who mentioned vendor transaction fees:
    It’s a little of topic but you may be interested: vendors pay transaction fees whether you use credit or debit cards. Also in case of Visa and MC, the rewards are paid to you by your bank which also gets interest and late fees (and suffers losses for defaults) whereas the vendor fees go to Visa and MC companies (for debit too – if used as credit; if used as debit – bank gets money from merchant). Visa company’s business model is built entirely around vendors’ fees, it’s not involved in lending at all.

  18. MasterPo says:

    Kitty – Gotta disagree about your point 1. I too have noticed that when I’m charging it I will tend to say WTF and buy a little more than if I had to pay cash on the spot.

  19. SJ says:

    I pinch pennies slightly less w/ CC’s but mostly cuz I usually have 0 cash on me.

    I think it’s just where you want your accountability. I like it at the end of the month. I can see if I spent too much etc., and adapt. I trust myself to adapt if need be in that sense.
    Upfront accountability is more if you don’t… tracking down purchases is harder =P so it’s more “oh snap I only have XX left, I better save”.
    If you are an auto-pilot but care about your spending CC’s are better, summaries help as opposed to empty wallets.

    Honestly, for most the peeps here I would imagine the extra spent w/ CC’s is negligible. The rewards is a nice perk, but the true reason is easier accountability and convenience and a level of security that cash lacks. Or so I hope =)

    As for my mention of transaction fees… it doesn’t matter to me if Visa or citicard or the vendor gets the “extra” money I spent; I lost that so sadness for me… (ignoring investments =P)

  20. Marc says:

    I like my Discover cash back card. I have never paid a penny in interest and I am paid about $200/yr.

  21. kitty says:

    @Master Po: “Kitty – Gotta disagree about your point 1. I too have noticed that when I’m charging it I will tend to say WTF and buy a little more than if I had to pay cash on the spot.”

    Plural of anecdotes isn’t data. You noticed you are charging more, but I noticed that I am careless with cash while at the same time I am always mindful about the final bill with CC. Especially on vacation – I spend more in cash-only countries than credit card countries even when the former countries are cheaper. Your personal experience doesn’t show that ‘everyone spends more” just as my experience doesn’t show “everyone who pays in full doesn’t spend more”. What they DO show is “maybe some of those who pay in full do spend more” and “not everyone spends more”.

    Counter-examples are valid if you are trying to disprove a supposition that “this works in every case”. Then a single case where it doesn’t work is enough. I.e. if I had claimed that nobody from those of us who pay in full is spending more with cards your personal example would be a good counter-example. But this was not what my point 1. said. It simply said that you cannot tell anything about individual behavior from the data about averages and that those who carry balances can easily account for these averages. It doesn’t say if all people who pay balances in full overspend or not, simply that data doesn’t prove that everyone spends more only that the total is higher. I.e. “it is true on the average” is not the same as “it is true in all cases”. For example, “on the average people get fat when they get older”,”my mother got fat when she got older”. You cannot conclude from these two statements that “everyone gets fat when he or she gets older”. There are people who don’t.

    I noticed that most Americans don’t learn the concept of proof in school. I noticed in in college when I was a TA – I was really surprised in how many exams of CS majors I had to simply cross out the solution that required a proof and write ‘this is not a proof” when people would show how what they were trying to prove in a couple of special cases.

    As to personal case – I think the fact that I do consistently have over half of my net income left at the end of the month – and this is after max 401K contribution – shows that I don’t need to worry about overspending. I also see my parents who have used credit cards their whole life yet clip coupons, and rarely make as much as one non-essential purchase. But… our personal experiences don’t prove anything about everyone. They do show that “not everyone overspends” — see the difference. Providing a counter-example is a valid form of disproving a supposition “this is true in all cases”. But it is not a proof of “it is not true in all cases”….

  22. TStrump says:

    I have a cash back credit card and while I do like using it and getting my rebate back each year, it is true that I would probably spend less without it.
    It’s just too easy to spend when I carry it around.
    At the end of the day, the rebate I receive is probably negated by the extra spending I do. I think credit card companies know and love this fact.

  23. I’m with TMN on this issue. However, I may be weirder than the average kitten about budgeting. For credit card spending (which, since I do not carry money around, includes everything except regularly recurring bills such as utilities), I have a strict budget and do not overreach it. For unexpected expenses that exceed budget, I use savings set aside specifically for the purpose.

    In those circumstances, it would be silly not to use a rewards card, since you’re getting something for nothing.

    But sometimes that “something” isn’t worth using the card instead of a different method. For example, if you buy a kitchen appliance from a store that offers a 12-month-no-interest deal and you have the cash to pay for the thing, it may be more to your advantage to put the money in a high-return savings account and let it accrue interest for a year than to charge it on your card for the sake of the 1 percent kickback.

    Personally, I find I spend less with a credit card than with cash. Cash flows through my fingers like water, and at the end of the day I have no idea where the money went. Credit card receipts and statements allow me to keep close track of what I spend and where, and that is a big first step in keeping a grip on expenditures.

  24. SJ says:

    The fundamental question is whether the fact you are spending credit will trick you into purchasing things that you wouldn’t otherwise.

    For people who are anal about pennies then I’m pretty sure they aren’t. For someone less anal abt budgeting and future planning; tougher call.

    So the questions isn’t if credit makes you spend more but if 1. manner of payment matters 2. how good you are at stickin to a budget.

    If paying with cash makes you underspend to the point you are miserable then uhh not good lol. If paying for cash lets you treat cash as 0 value… also bad.

    Judge yourself and viola~~~

  25. Matilda says:

    I’m flummoxed! You spend more money just because you have a credit card???? That’s your problem. I have a “friend” who has had all her credit cards taken away/canceled, and now she’s overdrawing with the debit card, and she’s bouncing checks. It’s her problem, not the credit card’s problem. A tool is a tool is a tool. All these “averages” quotes are just that: averages. That means half the people are, on a descending scale, are actually spending less with a card, while half are on the ascending scale and spending more. So sure, my “friend” shouldn’t ever have anything but cash, and when it’s gone, she should eat stale bread and drink water because nothing else will get it through her head that she has a finite amount of money. I, however, am not that person. If anything, like Ms Ferret, I’m deterred by the thought of seeing my purchases there in black and white on the credit card bill. When I have cash, I think that no one (i.e. my husband) will ever know what I’m spending. The point is, “know thyself.” If you can’t handle credit cards, then don’t. If you can handle them, why not get some cash back, some miles or nights, or whatever? Stop being so intransigent. We are all individuals and, if we know ourselves, we can make individual choices that are right for us.

  26. Julie says:

    I just discovered this website & post and wanted to share my 2cents, albeit late. I believe it is a simple truth that CC users spend more than cash users, on average, if for no other reason than that cash users sometimes refrain from buying simply b/c they don’t happen to have enough cash on them when they want to buy something. Of course there are exceptions, this is a general statement, so take it for what it is. For us CC users, it’d be an interesting experiment for us to leave our cards at home for a month and compare our total spending in that month vs. other months.

    But while I DO think that I’m a bigger spender with a CC than with cash only, I don’t think my piddly 1-3% rewards has made me an even bigger one. Having said that, I’m glad that I can use my rewards card to pay for upcoming big expenses, like tuition. I’d have to make these expenditures no matter what and the $1000+ cash back I’ll get will not be insignificant in my budget.

  27. Holly says:

    I am a late poster as well…I write each cc purchase in my checkbook (I know, still not the same as cash. That way I get to watch my account balance dwindle. The cash back is just a perk.

  28. Ptolemy says:

    Discover, the card I use [and the stock of whose issuing parent, Discover Financial Services, I recommend you consider for purchase] offers 1% cash bonus on just about everything. I put our Travelers flood Insurance, car maintenance, employer paid seminar travel and attendance, charitable donations…everything I can onto this card. Of course, I carry zero balance; we don’t buy what we cannot afford to purchase for cash.

    Of course, cash-back bonus notwithstanding, there is absolutely no future whatever in spending money but a rather splendid one in saving and investing it. Buy stocks, not junk at malls; don’t run up bar room and restaurant tabs. Let others do that while you buy the stocks of the companies that sell them the things they really don’t need but buy anyway. You can get rich doing just what I have told you and you can have the money to live very, very comfortably without worrying. You’ll get to the Royal Hawaiian Hotel, but not on credit and what’s great is that the rest of society will pay the bill. Good Luck.

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