When I first started using reward cards, it was very easy to place a value on my rewards.  My mental calculation went like this:  I got something for nothing.   Whohoo!

Maximizing Rewards Is A Bit More Complicated

Over time, I gained experience with various loyalty programs and/or their respective reward cards.     Ultimately, I started reading about reward cards, and even writing about them.   These activities caused me to think a bit harder on the subject of maximizing your rewards so hopefully, you won’t have to.   Ultimately, I came up with three steps to help me to make reward card decisions such as which card to get, and when to use one card over another.

Step 1: Compute Your Reward’s Realistic Valuation

Most people look at an award and try to determine what it would cost if they were to purchase the exact same product or service with cash.    This seems simple, but if you do it right, it is a bit more complex.    For example,  lets say I redeem 100,000 frequent flier miles I earned on my reward card for a first class, international ticket.    I then price that ticket out at $8,000.   Assuming I earn one point per dollar spent, am I getting 8 cents per mile in value from that reward redemption?  I would, but only if I would have actually spent $8,000 on the airline ticket.

To accurately determine the ticket’s true cost to you, figure out what you would actually pay for such a reward.    Perhaps there is a competitive airline offering a first class ticket for $6,000.    More realistically, most non-wealthy consumers would only be willing to pay to upgrade to first or business class for a few hundred dollars more than their coach ticket, not the several thousands of dollars more that the airlines price them at.

In another instance, you might use reward points to buy electronics from a manufacturer.   By doing so, you are not really saving the price the manufacturer shows on their web site, you are saving an amount equal to the best price you could have found elsewhere.

Ask yourself what you would have paid with cash for that reward, considering both your budget and it’s market value, and then you have it’s realistic value.

Step Two, Examine The Opportunity Costs

Now that you know what your reward is worth to you personally, find out what you are gave up both by earning the reward points or miles, as well as not paying cash for your reward.

When you earned the reward points or miles, you chose that particular card over others.    The best baseline for what you could have earned is a cash back card.   There are many cash back cards that give you 1% or more on anything, culminating with the Schwab Bank card that gives you a full 2% on everything, all of the time.   For the sake of argument, assume you could have earned 2% cash back on every transaction that you used to earn your reward points or miles.   So in the previous example of an airline ticket award that you redeemed your 100,000 miles for, keep in mind that you could have gotten $2,000 in cash back instead of those 100,000 miles.  Next, determine the value of anything else you would have received had you purchased the same ticket.    For example, you would have received frequent flier miles from both the ticket purchase and the flight itself.    Add the value of those miles as well as the cash back rewards you didn’t receive, and then subtract this amount from what you actually valued this reward at in step one.

It might be a little depressing to realize that you really aren’t getting much of a reward out of your 100,000 miles because you gave up $2,000 in cash by not using the best cash back card, as well as the $300 in frequent flier miles you would have gotten by purchasing a ticket.  Don’t worry, things get better in step three.

Step Three: Consider The Network Effects

Fortunately, reward cards do not exist in a vacuum, they are one of many ways to earn points in various loyalty programs.    It is unusual that you would actually earn all of your points through your credit card spending alone.    For most, they combine a sign up bonus with points or miles generated through commerce with the credit card affiliate.   In plain English, some people actually earn frequent flier miles by flying frequently, or so I have heard.    These miles by themselves might only be good for a flight to Buffalo in the winter, yet by combining them with those earned through your reward card, you are suddenly able to get a ticket to Europe.      It gets tricky, but you really have to consider your sign up bonus as well as the leverage you already had with a particular program.   If earning a few miles in one program or another “puts you over the top” for a particularly nice reward, it’s valuation can go way up.

Conclusions

Valuing rewards can be complicated, but when you are earning and redeeming rewards, you are making economic decisions that have a real value which can be measured in hundreds, if not thousands of dollars.    It is worth taking the time to consider realistic valuations, opportunity costs, and network effects to make the best reward card spending and redemption decisions.

This entry was posted on Tuesday, June 16th, 2009 at 18:00 and is filed under Credit Cards FAQ. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.