Credit card companies have created and sold us an alternative reality where we think they provide much better value than they really do. This has been so successful that many people will passionately defend their choice of card (especially the more premium the card is perceived to be) despite the overwhelming evidence that it represents very poor value for consumers
There are a number of reasons for this including:
Firstly, though, let's consider:
What is rarely considered when deciding to acquire a new credit card is the long-term value of Points (in which we include Miles) as an asset class. Instead, we focus on the acquisition incentives: 50,000 miles! 10x points!
But Points and their spiritual twin Miles are a rapidly depreciating asset — and that fact is entirely to the benefit of the issuers. It’s also one that you may actually not even own outright, with issuers typically retaining the right to close accounts for any reason. When they do, you simply lose the points you have accumulated.
Points and Miles are a currency where the issuer sets the exchange rate and the price at which you can buy actual tangible products. The difference between the value of these points can vary as much as 40% depending on what you buy. You would never accept this from a real currency.
It’s also an asset that may not even be an asset at all, as an article in Nerdwallet put it:
“Loyalty programs seem predictable — you earn, you redeem, end of story. But in reality, your issuer can change the rules of the game at any time. And it probably will at some point, for reasons such as rising expenses, competition or financial pressure.”
It’s a well-established path that when a new credit card is launched, the incentives and rewards are at their highest — the goal is to get positive reviews on recommendation sites and capture critical mass of customers. Then, the value diminishes.
In fact, even The Points Guy points out that points-based credit card rewards programs are not long-term investments:
The reason for this is simple: they are not designed to make you richer; they’re designed to stimulate you to spend more. The gamification of spending is in the economic benefit of the issuer; saving and investing more is in the economic benefit of the consumer. This distinction is important, and if you understand and internalize it then you are in a much better position to make informed decisions about your choice of credit card.
Even if we assumed a very optimistic neutral basis for credit card points, looking at relative performance as an asset class draws a very bleak picture.
Since we have established that Credit Card Reward Points are a really poor investment and an asset class designed to lose you money, why are they so prevalent and why do we still use them at all?
Sadly, our own cognitive biases are the result of culture and economics moving significantly faster than our own ancient biology and brain structure. Money is, on the evolutionary timescale, an incredibly recent invention. Our brains have not had time to catch up. This unfortunate reality makes us very poorly prepared to manage money — credit card issuers are all too aware of our shortcomings.
Exploring some of the main factors that influence our financial decisions, you can see how easily exploited we really are.
The Dunning-Kruger Effect refers to how people perceive a concept or event to be simplistic just because their knowledge about it may be simple or lacking. Put another way, the less you know about something, the less complicated it may appear. The Dunning-Kruger Effect occurs because people tend to overestimate their abilities or knowledge. Research shows that the majority of people will rank their skills — such as driving, healthiness, and ethics — as higher than average. For many people, that means overestimating their grasp of personal finance.
Credit Card Rewards are typically quite complex, which is no accident. Good luck trying to work out the real value and returns of your credit card. Most people cannot (even if they think they do) and that’s by design. Incumbent banks and issuers have vast resources to continually ensure that their cards are profitable, which means giving consumers back as little as they can while appearing to do the opposite.
If you cannot accurately describe and explain the returns on your credit card in less than 5 seconds, you are almost certainly not getting the best value on your spend.
So, you finally decided it was time to get that fancy metal credit card that all your more successful friends and relatives have. Loss aversion means that we feel psychological pain when we realize we’ve made poor decisions after the fact. Our brains try and avoid that by seeking out information that supports our decisions.
Relatedly, Confirmation Bias refers to the tendency to seek out information that supports something you already believe. So, you go on travel blogs on Instagram that profess to show how someone got Card X and managed to travel around the world by spending nothing out of pocket by strategically accruing miles and points (here is a helpful hint: they are paid by the credit card companies through affiliate deals). Or you look at r/creditcards on Reddit and read how random people profess to be experts on credit cards (see Dunning-Kruger effect) and show you how to “game” the system. These are not places to find objective and well-researched views on personal finance, but it’s painful to admit that you’ve been duped.
As the name suggests, Anchoring Effect refers to the way we rely too heavily on the first piece of information we receive (like an advertisement). This becomes our anchoring “fact”— and we tend to base all subsequent judgments or opinions on this “fact.” So, when you see that company A offers “3% Cashback” without reading the fine print or that they offer “50,000 points when you sign up,” even many years later, these facts stick. People asked about the return on their credit card will quote these ad headlines as fact. They become the reason for their choices even if they don’t reflect the reality of the true value of their card to them.
Ever since the Amex “Black” Centurion Card was launched in 1999, credit card issuers have sought to sell credit cards as status items rather than financial products. The reason is simple: the further away from a financial product in our perception, the less consumers will focus on the investment return. This is the reason that Miles and Points were invented - they’re well-branded Monopoly money, so we think about them very differently and value them much less than actual money. This phenomenon is well documented in psychology (see Mind Over Money by Claudia Hammond for more examples) and is roundly exploited by Big Brand Banks.
On top of that, the ability to tie certain cards to status has made us view these financial instruments in non-monetary terms:
“A premium credit card is typically associated with high social status and higher fees, but recent research suggests that people will choose them because it signifies higher income.
What’s more, the lower your self-esteem, the more likely you will opt for flashy credit cards with higher fees.” (Market Watch)
By turning your card into an accessory like a watch or piece of jewelry, the issuer can justify less value for money: after all, how can you put a price on the loud clank your card makes when you pick up the check at a dinner with friends. The more irrational we are about credit cards, the more we lose and the issuers gain. Honestly, what could be more irrational than choosing a credit card based on its weight?
The Big Brand Banks spend an awful lot of money to attract and retain your business — that money doesn’t go to building a better product or offering better returns on your money; it’s spent on advertising.
The Top 4 Banks spend over $10bn a year on advertising, almost all of which is spent in the United States. JPMorgan Chase alone spends more on ads than Apple does globally. This massive spend can make it very expensive for other smaller companies to enter and make a splash in the market. It gives the impression that Big Brand Banks are the only reasonable choice and allows a race to the bottom when it comes to value for money. But it's essential to remember: the Big Brand Banks are not your only choice.
We have established the majority of credit cards primary design criteria is to be highly profitable for banks. They do this by exploiting our cognitive biases and hiding the real returns they provide.
So, what's the alternative? What would the perfect credit card be like?
That seems pretty straightforward. Wonder why no one has done it?
The answer to that is also simple — it's not in the Big Brand Banks' economic interest to change. It will take a challenger that comes along that forces their hand; they won’t give up a profitable system without a push.
Until recently, it has also been almost impossible for challenger brands to even launch an alternative credit card model. It's a very slow and expensive process that has effectively locked out competition and innovation from the $4tr US credit card industry.
The great news is that this is changing. For the first time, new Fintech startups can enter the space and launch new and interesting credit card models. Finally, consumers really will get better value and have more choice in how they decide to spend their money.
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