Many people like to talk about earning miles and points as being free. While it’s true that putting spending rewards credit card will earn you something that you would not otherwise get if you paid in cash, once you hold a rewards credit card, the story changes. If you hold more than one credit card, there is a cost to earn miles and points. To maximize the amount of miles and points you earn, you should consider your opportunity cost of putting spending on a given credit card.
What is opportunity cost?
In economics, an opportunity cost is the loss of potential gain from other alternatives when one alternative is chosen. As an example, let’s say that I spend an hour writing an article for my website. I could otherwise be doing other things with my time. Sleeping. Working out. Playing Diablo 3. (Yes, I’m a nerd.) In every case, the things that I’m giving up in order to write this article are my opportunity cost.
But opportunity cost isn’t just an abstract concept only applicable to academics at universities. Everything that you do has an opportunity cost. And thinking about opportunity cost to earn miles and points can help you make better decisions about how you earn credit card rewards.
Your alternative is at least 2% cash back
So how does opportunity cost apply to earning miles, points, and travel rewards? When you put spending on a credit card in order to earn a specific reward, you are giving up the opportunity to earn rewards on that spending elsewhere.
I like to think of the opportunity cost of earning miles and points on spending for most people as 2% rewards. There are several cards with no annual feee that earn 2% cash back. And I recommend that everyone should almost certainly have one of these cards in their wallet. If you hold a 2% cash back credit card and choose to use a different credit card for your spending, you’re effectively paying 2% to earn your miles and points.
It’s pretty easy to think of your opportunity cost of spending as 2%. But depending on which credit cards you hold, where you are spending money, or how aggressively you go after credit card welcome bonuses, your opportunity cost could be much, much higher.
In some cases, your opportunity cost is higher
In some cases, you can get a credit card that earns more than 2% back on all of your purchases. The Bank of America Unlimited Cash Rewards credit card earns 2.62% cash back on every purchase if you have a banking relationship big enough to qualify for Preferred Rewards with Platinum Honors. If you hold this card and have Platinum Honors, your opportunity cost for credit card spending is at least 2.62%.
Some cards offer higher cash back rates for purchases in select categories like groceries, gas, or travel. The Blue Cash Preferred card from American Express offers up to 6% on grocery store spending. If you’re not maximizing the grocery store spending on this card, the opportunity cost of charging this spending to another card is 6%.
If you frequently sign up for new credit cards to go after welcome bonuses, your effective opportunity cost of spending might be much, much higher. Some of the best welcome bonuses earn an effective 20-40% cash back. (Consider that you might be earning a $200 welcome bonus for $500-$1000 of spending.)
Your alternative might be a cash discount
In some cases, you might have an opportunity cost that isn’t related to the credit card rewards you earn. Some merchants, especially smaller stores, encourage customers to pay in cash by giving a cash discount or charging a surcharge for credit card purchases.
If it’s 10% cheaper to pay cash for your $20 purchase, you can choose between earning 2% in credit card rewards ($0.40) or pocketing $2.00. Personally, I’d choose to have an extra $2.00 in my pocket.
An example using my Delta SkyMiles
To demonstrate how miles, points, and travel rewards cost you something, let’s look at how I think about earning status with Delta Air Lines. I currently hold Platinum Medallion status with Delta Air Lines. My status occasionally rewards me with a free upgrade to first class on domestic flights. Delta Platinum Medallion status requires spending $12,000 with the airline annually, plus earning 75,000 Medallion Qualifying Miles (MQMs) each year.
My travel patterns
I travel for work frequently, which earns me some amount of MQMs, but I don’t spend $12,000 on airfare for work. If I want status, I need to find another way. Enter my Delta SkyMiles American Express Platinum card. The card has an annual fee of $250. It offers a companion certificate every year, which I make use of, often for more expensive flights. For the sake of this example, let’s assume that the value I get from the companion certificate offsets the annual fee.
When I put spending on the card, I earn one Delta SkyMile for each dollar I spend. When I spend $25,000 on the card in a year, I get 20,000 MQMs, plus a waiver on the spending requirement to keep my status. Absent opportunity cost, it seems like an easy decision to hit this amount of spending. But when you consider that putting that spending on this card costs me something, the decision gets more complicated.
The value calculation
I have several 2% cards in my wallet, so I could earn 2% cash back ($500) on that $25,000 of spending. This means I’m effectively paying $500 to put $25,000 of spending on my Delta Platinum card. Of course, I get some benefits in return. From the spending, I get 25,000 SkyMiles. And I get 20,000 MQMs, plus a waiver on the spending requirements to keep my status. Is this worth $500?
For me, the value calculation ends up being worth it. Between the handful of upgrades I get every year, the fact that my Platinum status allows lounge access when traveling internationally, and the free same-day confirmed travel privileges I get when traveling on Delta, I get plenty of value. The benefits of having frequent flyer status, plus the miles I earn on the spending are worth the opportunity cost.
But if I were not chasing status, I’d effectively be spending $500 to get 25,000 SkyMiles. My travel patterns mean that I’m usually getting 1.1-1.4 cents per point of value from my SkyMiles, which is in line with the Cards and Points valuations. Spending $500 for (at most) $350 worth of travel on Delta Air Lines is a terrible deal.
Bottom line
Understanding and considering the opportunity cost of putting spending on a credit card will help you make better decisions about which cards to use. At the end of the day, if you think about opportunity cost, you’ll end up getting more value out of your credit card rewards and benefits.
Whether you’re going after a welcome bonus, putting spending on a card to earn points in a specific loyalty program, or putting a specific purchase on a card to get an insurance benefit, know that you’re always giving up something. You’re giving up the rewards you could earn on your next-best card.