Cashback or Airmiles: A Behavior Economics Analysis

The long debate between Cashback or Airmiles has been going on every since the existence of Airmiles. In Wealth Management, there are tons of literature whether Cashback or Airmiles which each camp strongly defending their point of view. I will be using a behavior economic lens to analysis this after being inspired by Pete who recently wrote an article on his decisions to choose between Cashback or Airmiles.

Will you choose “up to 2% of cashback” or “up to 4% of airmiles”?

Cashback or Airmiles

Cashback or Airmiles: I miss travelling

To answer the above question, I have to remodel the question so that we can use a behavior economic theory to answer it. These are the following assumptions that I will be taking.

Assumptions

  • I will assume that Pete receive the full 2% and 4% (noted there might be conditions to get up to the intended rates)
  • I will assume that Pete receive $200 and $400 (in monetary form)
  • The probability of using the cashback is 100% (you will definitely be able to use the money)
  • The probability of using the airmiles is xx% (airmiles might be devalued/you can’t fly/points expire etc)
  • The traveler is paying the airfare out of their own pocket. (Thank you Philip Walsh for your contribution)
  • I recognize that airmiles are a specific spend in the travel category but will be treating it as if it is equal to cash

 

Which will you choose? 100% of getting $200 or xx% of getting $400?

One common way to approach this problem is using the concept of expected returns. In this case, if there is a chance of getting more more an 50% of getting $400, it is logical sense to go for the latter option. However, emotionally we might not feel the same.

In my previous sharing on Self Care and Wealth Management, I wrote about emotions being part of our decision making process and it is the same in this case. The behavior economic concept that I would be sharing with you is the certainty effect.

 

The Certainty Effect

Behavior Economist Dr. Daniel Kahneman propose a concept called the Fourfold Pattern. 

Cashback or Airmiles Fourfold Pattern

Cashback or Airmiles Fourfold Pattern

While we are not going to go through all four patterns, the behavior pattern that I would illustrate today’s case is in the top left section. These are the choices.

Choice #1: 95% of winning $10,000
Choice #2: 100% of winning $9,000

Clearly, choice #1 is ideal because the expected payout is $9,500. However, most people will choose choice #2 because the emotion called fear of disappointment. They rather “lock in” the profits in a high probability scenario. In certainty, most people are risk adverse.

 

The Final Verdict

In a real life scenario, we are unable to set controls in our experiment but we can draw inference from the certainty effect.

Choice #1: 100% of $200
Choice #2: xx% of $400

I believe most people will choose choice #1 because they are motivated by the fear of disappointment. There are too many uncertainty such as airmiles depreciation, airtravel resumption and expiry of points with choice #2. That being said, airmiles are can only be used in a specific category while cash will.. be cash.

I recognise that there will be some that will continue to choose choice #2 and may be motivated by other behaviour emotions.

How about you? What choice will you make?

 

No one will care about your money as much as you do.

In Wealth Management, it is important to Pay yourself first. Beware of scams. Before you invest in any company or popular investment opportunity, be sure to do your own due diligence. If you wish to learn more about investment, I hope to nurture genuine relationships with all of my readers.

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