I am going to let you in on a little secret. Those who are poor with money subsidize those who are good with it. From brokerage deposits, to loan rates, and even to travel hacking. Those of us who manage our finances diligently benefit greatly from those who are poor with money.
Know the Game So You May Benefit
Now before we get started I want to clearly state, nothing in this post should be construed as a political or moral position either way on how things should be. This post is purely how things are. Understanding how things work is the key to being on the better end of the deal. Whether you benefit of not will not change the situation, so you are better off benefiting. Then utilize those benefits to help others become better at managing money. With that said let’s consider my point, that those who are poor with money subsidize the rest of us.
Poor Credit Card Management Subsidizes Travel
Let’s consider travel hacking and credit card cash back. These are immensely beneficial to those who pay their cards on time consistently. You can take 0 percent loans, get immense amounts of cash back on purchases, and even travel the world for next to nothing. These things require you to be good at managing credit cards and to use them correctly.
But there are 2 clear losers in the credit card travel hacking game. The first are those who do not pay their loans on time. They subsidize the credit card company’s rewards via usury rates of interest and fees. Without these folks the card companies would not be able to offer those wealthy signup bonus’s or cash back.
The second loser in the cash back game is the person who pays cash. Each credit card company charges the merchant a fee for the use of the card. This fee is different depending on card but is probably in the 2% range. These fees are then passed on to those who make a purchase in the form of an increase in price. After all, any company who wants to stay in business is going to pass any and all cost increases to their customers so long as they can. A company that can’t cover its costs from revenues from its customers is not long for this world.
Anyway, I digress. For most cases you pay the same amount for an item whether you pay with cash or card. This means those paying cash are helping to share the offset in those transaction fees. Meanwhile they are not receiving the cash back or points benefits of their card brethren. Those who choose or cannot use credit cards subsidize those that use them responsibly.
The Brokerage Account Subsidy
Those who manage money poorly subsidize those that manage it well in other ways as well. Take brokerages and 401ks. Do you know where most of the large brokerage house makes most of their profit? The same way a standard bank does. They take your cash deposit and loan it out to someone else. The spread between your interest and theirs is a huge chunk of their profit.
Many of those brokerages are paying something like .01% on cash holdings. If the going rate for a 1 year treasury bill is 2% that means that brokerage is cashing in a 1.99% profit on any money you deposit that sits around for a year. So he who lets his cash sit idle in a brokerage account is keeping the costs down for everyone else as a greater proportion of the revenue and profits are coming from the cash depositor.
Retirement Account Subsidy
The same can be said for 401Ks. Very few 401ks charge set fees to their participants. Does this mean your company is paying the fees for your 401K? Or how about the brokerage providing it out of the goodness of their heart? Again no.
Typically larger 401Ks get some sort of kick back from funds for including them in their offerings. That kick back is part of the funds expense ratio. My own 401K, for example, has a selection of low cost index funds and high cost active managed accounts. Given how low the expense ratio is on those index funds it’s obvious he who invests there is not footing a significant portion of the 401K fees. That being said those that are buying the high cost options almost certainly are footing a larger portion of the 401k fees.
The ramifications don’t end there though. Whole Industries are based on the concepts of the poorly managed subsidizing the rest of us. Take lending. One of the big reasons a 800 credit score individual can get such a low rate on say a car or other vehicle is all the other people paying much higher rates due to poor credit. Why else do you think so many car companies either have partnerships or their own in house lending group. It’s certainly not to make money off the occasional 0% car loan.
Even shopping has similar concepts. The ideas of discounts and rebates is purely based on a subsidy model. This can be seen in a few different ways.
The first is the loss leader or marketing promotion where one thing is marked down and everything else might even be marked up. They get you to come in and make the cheap purchase in the hopes that you’ll buy the expensive stuff as well. The people that actually buy the expensive items are subsidizing that person who comes in and only buys the loss leader.
The second example is the person that does the rebate or coupon. To review companies price at the point where supply equals demand. But honestly demand is not a stable thing across the populace. Some people have a higher demand then others. So if you can segment that demand via pricing for different groups you can capture more profit.
The achievement of the desired profit is measured across the whole pie though. So say I want to make an average $3 per item profit by selling something. I have 75 people that want to buy the item for $20 and 25 that would only buy at $16. It costs me $15 to make the item. The people willing to pay $20 allow me to sell the item to those paying $16 while still making my desired profit per item and increased overall profit. That is without even considering left over excess stock and out of fashion items. So he who shops around for good deals is subsidized by the first people to buy and the non-cost conscious.
The Health Care Exception
Before closing out I’d be remiss if I didn’t mention the one exception to the rule. Those who manage their health well do subsidize those who manage their health poorly. Insurance in general is one of the few areas of life where being good at something costs you a proportionally higher amount then your usage. Honestly in some ways insurance disincentivizes proper management. That being said one can hope the whole death or disablement thing is enough of an incentive in these areas by itself.
Can you think of other areas where proper money management is subsidized by those that are poor with money? Does this post make you want to improve your money skills at all?
Love this post FTF.
Great point on healthcare too. It is true that if you exercise and eat well you are not likely to make use of your health insurance compared to someone who smokes and is unhealthy. Insurance companies thus count on you not abusing the system to offset the costs of those that do.
I’d still much rather not have to use it. 😉
The leading edge and luxury item shoppers? They bring down the overall price and make it available to the rest of us at a cheaper price point later.
Good point about healthcare.
Thanks Joe. Without those leading edge folks we wouldn’t have things like the Smartphone or computers. I for one appreciate those early adopters, even if I’m too cheap to be one.
Good point about loss leaders. They’re subsidized by the fact that once you’re in the store, you’re likely to get “just a few more things since I’m here.”
Definitely true on lending and credit, too. Those card bonus offers come because too many people get the card for the offer then either don’t meet the terms or run up a bill they can’t pay off.
I like the point about how paying cash is essentially losing out. Not something I’d thought of before, but as someone who uses her 2% rewards card for everything, I have to say I agree that people who pay cash are missing out!
Your title left me intrigued, but now that I’ve read your post, I know what you mean. For example, we joined our tennis club, but we negotiated before we did it. We didn’t pay the full price, but waited until they lowered it and gave us a discount on our monthly membership fee. We were’t trying to pay less than our neighbors; we had just heard that they would discount the fee several times a year so we waited to join until then. Lots of other friends paid the full price because they didn’t want to wait. I don’t necessarily want my neighbors to subsidize us, but I wasn’t going to pay more than I needed to, either.
Great example. Patience pays.
Great article. Just looking at coupons shows that those who spend a little extra time can pay a lower price. I’d caution though that ” being good with money” turns destructive and borders on stealing at times. For example, if you use retail stores to try things out and then buy the items online, you’re really taking advantage of the stores. Repaying others who provide a ” free ” service by purchasing from them is part of the deal. How would you like to spend a half hour helping someone, only to have them buy the item elsewhere? If you don’t want to buy from someone to save a buck, only shop online. If you want service, you need to be willing to pay for it. Otherwise, it won’t exist.
Interesting philosophy… I’m not sure I’m quite to the point where I feel obligated to buy from the store I try at. That being said I can’t recall the last time I tried either so kind of moot.
However, I will say the folks that buy something and then return it after using it don’t sit well with me.
Great post. It’s unfortunate that our major institutions prey on those that are not financially literate (like you said- know the game). It’s important to be aware of the game, and you laid out the major examples in which we see this.