small change toward a rich life

The credit card rewards system is gaming you

Warnings against credit cards, while common, are almost always of the ‘don’t carry a balance’ variety. Over and over, we are told that as long as we pay off your balance each month and avoid fees and interest charges, we’ll come out ahead.

girl grimacing, holding Citibank MasterCard in her teethI’ve noticed that bloggers in particular love to trumpet the advantages of rewards cards — perhaps in part because they make money with referral fees — but also because they can look like a good deal for the consumer, on the surface.

I mean, everyone has to spend some amount of money each month, no matter how frugal they are or how tight their budget. And if you’re going to spend money, you might as well get a discount for it — a couple of percent in cash back, or Amazon gift cards, or frequent flier miles. Right?


•   •   •

Mind you, this is exactly what I’ve been doing for years. After paying off our enormous credit card debt, I picked one cash-back rewards card to keep using. Later I split our purchases between that card and a debit card from our high yield checking account. Everything passes through one of those cards. Cash spending is almost unheard-of; we typically go years at a time without hitting an ATM. Even with our currently circumscribed expenses, we still get a few hundred dollars from this strategy each year.

Recently, however, I’ve become convinced that this is a not such a good idea.

•   •   •

You can’t read very much in the field of consumer psychology without running across the fact that people who use credit cards spend more than people who pay in cash. This has been generally accepted both among researchers and within the industry since the late 1970s. By the late 1980s scientists had proven that this was not a merely correlative effect — that credit cards actually cause people to spend more, rather than that cards are used by people who are naturally higher spenders.

For the last thirty-plus years, research and debate has largely centered around determining the reason for this phenomenon. No single clear answer has emerged.

Rather, it’s evident that there is no single reason, but several. Roughly a handful — depending on how you choose to divide things up — of different psychological processes are contributing to what is now called simply ‘the credit-card effect’. To make things even more complicated, not every factor applies to every person or in every circumstance, which has led to some confusion as some studies seemed at first to contradict other findings.

There’s enough research out there for at least a half-dozen meaty blog posts, so for now I’m going to focus on just the one phenomenon that I found most surprising.

•   •   •

door full of credit card logosAll the way back in 1986, before I was even old enough to have a credit card, a consumer psychologist named Richard Feinberg conducted a series of four experiments that showed that a credit card logo alone was enough to increase spending. In two experiments, he had subjects flip through a binder containing images of consumer products (taken from mail order catalogs) and write down how much they would be willing to pay for each item.

Half of the subjects followed these directives while sitting at a table containing a pile of MasterCard paraphernalia — door signs and replicas of credit cards — ostensibly left over from a prior experiment. The other half sat at a bare table.

Here are the average amounts (1986 dollars) that were offered for each item in one of the studies:

Product Logo absent Logo present Increase
Toaster $  21.50 $  67.33 213%
Black-and-white TV $  67.00 $ 136.92 104%
Lamp $  34.42 $  47.17 37%
Digital clock $  18.08 $  31.25 73%
Pocket camera $  29.58 $  52.67 78%
Home stereo system $ 157.42 $ 191.17 21%
Dress $  25.42 $  49.42 94%
Mixer $  17.75 $  36.25 104%
Tent $   7.58 $  28.42 275%
Saw $  33.42 $  67.33 101%
Chess set $   8.67 $  25.75 197%
Cassette tape recorder $  26.50 $  42.75 61%

When I saw those numbers, I actually exclaimed out loud. Previously, when I’d read that ‘credit cards make you spend more’, I’d been imagining something small — a few percent, maybe. Not twenty percent more, and certainly not more than triple. Gah!

•   •   •

Now here’s the kicker: this ‘logo’ effect is the result of associative conditioning, so it doesn’t apply to everyone.

In fact, followup studies have indicated that credit cards facilitate spending only in people who have had positive experiences or associations with credit cards. “Numerous aversive experiences” — such as repeatedly paying large fees and high interest — had the opposite effect, and actually dampened spending. Media attitude also matters; in New Zealand, where the government has been waging a pervasive anti-debt advertising campaign for years, credit cards were recently (Lie et al., 2010) found to have a predominantly negative impact on spending as compared to cash.

credit card logos and USA flag on shop doorHere in the good ol’ U.S. of A., however, the cultural view of credit continues to be generally positive, and research from the past decade continues to show that credit cards facilitate higher spending. There are studies showing people spend significantly more at the grocery store, in restaurants, in auctions for sports tickets, for gifts, when giving to charity … pretty much anything where the amount has a discretionary aspect.

In other words, the more you like credit cards, the more dangerous they are. Which means, in turn, that all of us ace personal-finance types who think that we’ve been gaming the system and getting something for nothing … are ourselves being gamed.

•   •   •

Inevitably, most of you who are reading this will think something like, “Yeah, maybe that’s true for some people, but not me — I am too smart / sophisticated / disciplined to be affected.”

We all like to believe in our own superiority — so much so that social psychologists and behavioral economists talk about the superiority bias — also known as ‘illusory superiority’ or ‘the Lake Wobegon effect’, after Garrison Keillor’s fictional town where, impossibly, “all the children are above-average”. David McRaney explains it both amusingly and well in his book You Are Not So Smart:

The last thirty years’ worth of research shows just about all of us think we are more competent than our coworkers, more ethical than our friends, friendlier than the general public, more intelligent than our peers, more attractive than the average person, less prejudiced than people in our region, younger-looking than people the same age, better drivers than most people we know, better children than our siblings, and that we will live longer than the average lifespan. (As you just read that list, maybe you said to yourself, “No, I don’t think I’m better than everyone.” So you think you’re more honest with yourself than the average person? You are not so smart.) No one, it seems, believes he or she is part of the population contributing to the statistics generating averages.

On average, people who like credit cards spend more with them than they would if they used cash — a whole lot more.

Do you look upon your credit card with fear and loathing? If yes, you can perhaps safely ignore this particular effect (though not several other ones that also result in greater card spending).

ad for Target Visa card with happy womanOn the other hand, if you’re happily socking away your 3% cash back or collecting airline miles while paying off your balance each month, you are the very definition of ‘positive association’, and you can be sure that you are paying for those perks with higher credit card bills.

•   •   •

The saddest thing, to my mind, about the logo-exposure effect is that debit cards provide no relief. A 2011 study by Amy Moore and Michael Taylor confirmed this, showing that debit-card spending is just as dramatically elevated as credit-card spending when there’s a Visa or MasterCard logo present. So you can’t curb expenses just by switching to debit — you have to go all the way to actual cash. Since I like the convenience factor of plastic even more than I like the cash bonuses, this was not good news.

These days, I am meticulous in my financial responsibility. But I have been too humbled by my research into behavioral economics to believe that I am specially immune to these sorts of psychological effects. Also, frugality is more important to me than ever right now: Jak and I are both attempting to jump tracks into different careers and trying to support ourselves without full-time day jobs. The ability to keep costs down is critical to our success.

sign: Hoxton Street Monster Supplies / Cash OnlyWith that in mind, I’ve decided to see if I can give up credit and debit cards. I even convinced (a slightly reluctant but good-natured) Jak to try it along with me.

More about our personal anti-plastic experiment in my next post.

Have you ever given up credit cards? Would you consider switching to cash to save money? If not, why not?


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