The Illusion of Credit Card Rewards Programs
Credit 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’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.