I recently listened a the long episode about Visa on the Acquired podcast, and it was fantastic. Visa is one of those companies that we all think we know, but it’s really quite confusing. From the show:
Visa does not extend credit. They do not issue cards. They do not work directly with merchants. They do not work directly with consumers. They are not a bank or a financial institution. They don’t ever bear any risk.
So what do they do? It’s a long answer, which the show answers well, but they essentially just connect banks to other banks and they make billions of dollars every year from doing it.
As they unpacked the episode, they spent a while talking about how “rewards” cards work. Specifically, how can companies afford to give away cash back, airline miles, and other perks while also paying the fees for running the cards? You guessed it — they raise the prices of the items that they sell.
And they don’t just raise the prices for users with a certain card, they raise the prices for everyone. This means that if you’re not earning rewards on your purchases, you’re losing money. A study from the Federal Reserve Bank of Boston put it in perspective.
- If you pay with cash, it costs you an additional $149 per household over the course of a year.
- If you use a card, you gain $1,133 in extra rewards over the course of a year.
That’s a huge difference! Also, that study was from back in 2010, so the gulf has almost certainly widened since then.
Rewards-based cards can be very beneficial, but those benefits are baked into the prices. If you’re not getting rewards, you’re literally losing money.
Mathematically this makes sense. An item paid for in cash can cost more than an item paid for via credit card once you net out the cost of the reward. However, this doesn’t take into consideration the behavior that is created when using credit cards.
There have been numerous studies that demonstrate consumers spend more money overall when using credit cards vs. cash. This is typically attributed to one of 2 reasons: they don’t “feel the pain of spending” because the bill doesn’t come for a month OR the reward center of their brains are triggered by thinking “I’m getting an extra benefit for making this purchase” (the rewards program you note above).
Ultimately, cash ends up being less expensive because consumers spend less per transaction when using cash (or debit cards) compared to credit cards. In theory, you are losing money with cash, but in practice you are losing money with credit cards by spending more than you otherwise would.
Here’s a couple of links to articles and studies on the topic.
Boston Federal Reserve study: https://www.bostonfed.org/publications/research-data-report/2017/the-2016-diary-of-consumer-payment-choice.aspx
MIT article: https://mitsloan.mit.edu/experts/how-credit-cards-activate-reward-center-our-brains-and-drive-spending
Well said. I guess I should change it to something like “if you spend the exact same amount, you’ll do better using cards”.
Years back, Kelly and I did the “cash envelope” system for budgeting for the exact reasons that you shared. It was a pain, but it worked quite well!