Latest / Behavioral Economics with Fexingo: Decision Making, Bias, and How People Really Spend / Why Your Brain Treats Loyalty Points as Fake Money
Transcript
- Lucas: Luna, how many unused airline miles do you think you have sitting in your account right now? Luna: Oh, probably around 80,000 across Delta and United. And I'm sure I'll never use half of them. Lucas: Right. And when was the last time you redeemed miles for a flight and actually calculated the per-mile value? Luna: Never. I just see they're enough for a ticket and I click 'book.' It feels free. Lucas: That feeling — that points feel free — is the subject of today's episode. There's a growing body of research on what economists call the 'points illusion.' A 2023 study out of the University of Toronto's Rotman School of Management found that, on average, consumers spend about two and a half times more when paying with loyalty points compared to paying with cash for the exact same item. Luna: Two and a half times more? That's massive. So my brain just doesn't register points as real money. Lucas: Exactly. And the study controlled for income, wealth, and product category. It's a pure behavioral effect. The researchers call it 'mental accounting separation' — you mentally put points in a different bucket than cash. And that bucket has a much higher spending threshold before you feel pain. Luna: So it's like the pain of paying is turned way down for points. Lucas: That's exactly it. The pain of paying — that visceral discomfort we feel when we hand over cash or swipe a credit card — is almost absent with points. A 2017 study by Promothesh Chatterjee and Randall Rose found that when people pay with points, neural activity in the insula, the brain region associated with pain, drops significantly compared to paying with cash. Luna: So my brain literally doesn't feel the sting. That explains why I once redeemed 150,000 SkyMiles for a business class ticket to Tokyo that I later calculated was worth about 1.5 cents per mile — terrible value. Lucas: That's a perfect example. You paid effectively $1,500 in forgone value — because you could have gotten a cash ticket for $1,500 and saved the miles for a better redemption. But because the miles felt like free found money, you splurged. Luna: And I wasn't alone. Airlines and hotels design these programs specifically to exploit that illusion. Lucas: They do. The points illusion is a deliberate feature, not a bug. Think about Starbucks' rewards program: you earn stars, and a free drink costs 150 stars. But the average star is worth about 12 cents when you do the math. Most customers never do that math. They just think, 'I have stars, I'll get a free latte.' The company reported last year that rewards members spend three times more per visit than non-members. Luna: Wait, three times more? So the program isn't just a loyalty tool — it's a spending amplifier. Lucas: Exactly. And here's the twist: the illusion works even when you know about it. In the Toronto study, they told half the participants explicitly that points are equivalent to cash at a specific rate. It didn't matter. Those participants still spent significantly more with points than with cash. The mental accounting is that sticky. Luna: So even being aware of the bias doesn't stop it. That's a little humbling. Lucas: It is. And it's tied to another concept we've talked about on the show: the 'found money' effect. When you get a tax refund or a bonus, you're more likely to spend it frivolously because it feels like a windfall. Points are the ultimate found money because you earned them passively by buying things you'd already buy. Luna: I've definitely done that. I'll put a big purchase on my card just to earn miles, then redeem those miles for something I wouldn't have bought with cash. It's a double spend. Lucas: That's the classic 'points-induced spending' cycle. And companies love it. A 2020 study from the University of Chicago Booth School found that credit card rewards programs increase total spending by 12 to 18 percent among enrolled users, even after controlling for income and baseline spending. Luna: So I'm basically paying more for everything because I've got a shiny rewards program in my wallet. Lucas: In many cases, yes. And the most profitable customers for these programs are the ones who don't pay off their balance every month, because they're paying interest on top of the spending. But even for people like you who pay in full, the behavioral effect is real. Luna: Let's talk about a specific case. I have a friend who's a huge Delta loyalist. He has the Platinum AmEx, earns five times miles on Delta purchases, and never flies anything but Delta. He recently told me he redeemed 200,000 miles for a first-class ticket to Europe. When I asked what the cash price was, he said he didn't check. He just saw the miles were enough and booked. Lucas: That's a textbook case of the points illusion. The cash price for that ticket was probably around $3,000. At 200,000 miles, that's 1.5 cents per mile — slightly below the average redemption value for Delta miles, which hovers around 1.2 to 1.4 cents. But if he had paid cash, he'd have earned miles on that purchase, plus the credit card bonus. The opportunity cost is real. Luna: And he's not alone. The Points Guy publishes annual data on average redemption values. For Delta SkyMiles, the average is about 1.3 cents. But most people don't even come close to that. They redeem at rates below 1 cent per mile because they just use miles for small purchases like Amazon items or merchandise. Lucas: Right. And that's the other side of the illusion: points are sticky. People hoard them, and then redeem inefficiently because they don't want them to expire. A 2021 study from the Federal Reserve Bank of Boston estimated that U.S. consumers hold over $100 billion in unredeemed loyalty points and miles. Luna: A hundred billion dollars just sitting there. That's a huge liability for companies but a huge behavioral trap for consumers. Lucas: Exactly. And the companies count on that. They treat unredeemed points as 'breakage' — essentially, money they don't have to honor. When you finally redeem, you're often getting a worse deal than if you'd just taken the cash equivalent. Luna: So what's the practical takeaway? How do we break the illusion? Lucas: One approach is to mentally convert points to cash before every redemption. You can say, 'This flight costs 50,000 miles or $500. That's exactly 1 cent per mile. Is that a good use of my miles?' If you wouldn't pay cash for the item, you shouldn't use points for it either. Luna: But even doing that math, I still feel the pull. There's something about seeing a zero-dollar price that just bypasses my rational brain. Lucas: And that's the final piece of the puzzle: the illusion is rooted in our brain's reward system. Earning points triggers a small dopamine hit — it feels like progress. Redeeming them feels like a win, even if it's a bad deal economically. It's the same mechanism that makes slot machines addictive: variable rewards and intermittent reinforcement. Luna: So we're not just bad at math. We're wired to be vulnerable to this. Lucas: We are. And the best defense is to slow down. When you're about to redeem points, pause. Ask yourself: 'If I had the cash equivalent in my hand, would I spend it on this?' If the answer is no, don't use the points. Luna: That's good advice. And speaking of slowing down and thinking about value — if this episode made you reconsider your own rewards habits or just gave you a few minutes of useful perspective, we appreciate that. We keep this show ad-free, and listener support is what makes that possible. If today felt worth a coffee to you, there's a link at buy me a coffee dot com slash fexingo. Lucas: Yeah, and it genuinely helps. We don't run ads, so every bit of support goes straight into research and production. No pressure — just if you found value. Luna: Exactly. And now, back to the points illusion. One last example I wanted to share: a colleague of mine redeemed 15,000 Hilton points for a free night that would have cost $150 cash. That's exactly 1 cent per point — pretty good for Hilton. But she didn't check the cash rate; she just assumed the free night was worth more. In reality, she had options that would have yielded 1.5 cents per point if she'd looked. Lucas: And that's the thing: the illusion isn't just about spending more — it's about leaving value on the table. Points programs are designed to be opaque. They use dynamic pricing, blackout dates, and tiered redemption rates to make comparison difficult. The more complicated the math, the more likely we lean on the 'it feels free' heuristic. Luna: So the antidote is transparency. If you track your points' value per redemption, you can actually beat the system. Lucas: Exactly. And there are tools now that help. Apps like AwardWallet let you track your points balances and redemption history. But even a simple spreadsheet where you note the cash price and the points cost will start to rewire your mental accounting. Do that three or four times, and you'll start to feel the pain of a bad redemption. Luna: So the next time I see those 80,000 miles in my account, I'm going to mentally tag them as about $1,040 at 1.3 cents each. That might make me think twice before blowing them on a flight I don't really need. Lucas: And that's the goal. The points illusion is powerful, but it's not insurmountable. The first step is just recognizing that those numbers on your screen are real money — and your brain is lying to you about them. Luna: Alright, that's our show for today. We'll be back next week with another behavioral economics deep dive. Lucas: Until then, watch those miles.