Warren Buffett Helps Explain Large Credit Card Sign-Up Bonuses

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I’ve been an admirer of Warren Buffett and his partner Charlie Munger since I was a teenager and have been lucky to attend the last 5 Berkshire Hathaway shareholder meetings in Omaha, Nebraska.

Warren Buffet – Creative Commons Image By Mark Hirschey
I even got Buffett’s autograph on a dollar bill as he chuckled “Son, I just doubled your money!”

As the most successful investor of all time, Buffett is serious when he says:

“Rule No.1: Never lose money

Rule No.2: Never forget rule No.1

So why is Buffett happy when GEICO – the large insurance company which is also a Berkshire Hathaway subsidiary – spends $900 million on advertising to attract new customers?

Not only is $900 million the largest amount spent on advertising by an auto insurance company in the US, but it is twice that of the runner-up advertiser in the auto insurance business.

Now I agree that the GEICO gecko is a charming little reptile and injects much needed humor in our lives.  But is it really worthwhile to spend $900 million on advertising to get new customers for GEICO?

Here’s what Buffett wrote in his 2010 shareholder letter (bolding mine):

At GEICO, for example, we enthusiastically spent $900 million last year on advertising to obtain policyholders who deliver us no immediate profits.

Not only is Buffett spending $900 million to attract new customers, but those new customers are not even immediately profitable!

At 80 years old, does Buffett still know what he is doing?

You betcha!

At 80+ years, Buffett and Munger can still out-think and out-invest millions billions of younger men and women.

The reason why Buffett is delighted at spending close to a billion dollars on advertising now, to attract new customers, is because he knows that these customers will be profitable in the future!

Warren Buffett is the consummate long-term investor, and he doesn’t mind plonking down $900 million to get customers who will earn him much MORE than $900 in their lifetime association with GEICO.

As Buffett explains (bolding again mine):

If we could spend twice that amount productively, we would happily do so though short-term results would be further penalized. Many large investments at our railroad and utility operations are also made with an eye to payoffs well down the road.

Buffett knows that once customers sign-up with GEICO, they will be less likely to leave GEICO, even if they could save money by switching to a different insurance company!

This “sticky” behavior is the reason why companies spend billions to try to get you to try out their product.

Personal Experience: For years, I had Progressive car insurance and – I hate to admit this – never bothered to check rates with other car insurers.  I now switch my car insurance every 6 months between GEICO and Progressive, since they offer lower rates to sign me on as a new customer than they do to keep me as an existing customer!

Credit Card Sign-Up Bonuses

Buffett’s eagerness to spend $900 on advertising to acquire customers who are not immediately profitable helps explain why banks offer large sign-on bonuses with credit cards.

Banks don’t offer large credit card bonuses  because they are mismanaged or because they want to fund your travel dreams. 🙂

You are offered large credit-card sign-on bonuses to entice you to sign-up for credit cards and make the banks money!

Because the banks know that, on average,  once you sign-up for their credit card and start using it, you are likely to continue to use their credit card and  pay interest, annual fees, or late payment fees which will more than make up for the cost of the sign-up bonus.

Banks also get paid a small percentage of every transaction you make using their credit card.

And the banks have done the math to know that, on average, they WILL make a profit by issuing you a credit card.

Credit card divisions of banks make billions of dollars by issuing credit cards!

In the first 3 months of 2011, the credit card divisions of Chase and Bank of America reported net income of $1.3 billion and $1.7 billion respectively!

The Census Bureau estimates that there are 1.3 billion credit cards in the US.

This saturation makes it hard for banks to get folks to sign-up for new credit cards, which is why they sweeten the deal by offering large sign-on bonuses.

Savvy Consumer

A reader wrote in asking if taking advantage of credit card sign-up bonuses was unethical and perhaps damaging to other consumers who don’t apply for credit cards solely for the mile and point bonus.

I don’t see anything wrong in applying for a credit card and getting the sign-on bonus and continuing to use the credit card responsibly.

Using your card responsibly means, not incurring late payment fees or paying interest, and cancelling the card when it no longer meets your needs.

In my opinion, your primary obligation is to make the best choice for you and your family.

It is not to consider the well-being of large companies that make billions of dollars in profits.

That’s not because I don’t like large companies ( I do like ’em!), but because large companies pay lots of money to managers who are supposed to make decisions which are in the corporation’s best interest.

As Adam Smith explained:
It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest.

Banks issue credit cards with large sign-on bonuses with regard to their self-interest.  That is all there is to it.

Remember that the bank will be making money, even if you don’t pay interest and fees, on every credit card transaction which you make!

Bottom Line

Banks hope to make money off you by offering large credit card sign-on bonuses.

But by using your credit card responsibly (not paying interest or fees) you can use credit card bonuses to have Big Travel with Small Money.

Credit card bonuses are the largest and easiest way to get miles and points without actually flying in planes or staying in hotels!  See the Hot Deals tab for my selection of the top current deals.

Remember that your credit worthiness is very important, and that you should not go overboard by applying for too many credit cards.

I limit myself to 3 or 4 inquiries every 6 months from each credit bureau, but that may not be the right number for you.  You need to determine the right limit for yourself taking into consideration the nature of your credit history, financial and travel goals, and how aggressively you want to play this game!

I do not recommend applying for credit cards to earn miles and points if you will be applying for a large loan (house, student loan, equity loan etc.)  in the next 2 years.

You will get much more happiness from your house or education, and shouldn’t do anything to jeopardize that prospect.

What do you think? Have you applied for a credit cards because of the sign-up bonus?  Tell us about it in the comments!

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