Comments from reader msf on the previous post Keep Your Airline Miles Active Via Online Shopping Portals gave me the idea for this post. You keep your airline miles active because one day you want to redeem those miles for a flight. Putting aside the small fee you will still have to pay when you book a reward flight, is the reward flight free?
Pay Forward
Some say of course it’s free because you don’t have to pay when you book the flight (again ignoring the small fee). It’s not so obvious that it must be free only because you don’t pay at the time. Besides financing, which makes you pay later, you can also pay ahead. Some stores offer layaway plans by which you pay multiple small amounts toward an item until the store finally releases it to you. When your miles are earned from paid flights, the reward flight is most like a layaway plan. With each paid flight you pay a small amount toward a future flight. When you paid enough those small amounts you finally get a future flight for “free.”
Opportunity Cost
What if you got your miles from credit card signup bonuses, charging purchases on credit cards, or online shopping? It’s also not so obvious that it must be free only because you didn’t pay cash. As msf pointed out in the comments, in all those activities you are foregoing something else. You could’ve signed up for a credit card that gives a cash bonus or used a card or site that gives cash-back as opposed to miles or points. In choosing miles and points you give up cash-back. In essence you are buying the miles and points with cash-back you could’ve received. Some credit card points can be turned into either airline miles or hotel points or cash back. If you choose airline miles or hotel points, you are again essentially buying the miles or points with the cash back you could’ve chosen.
Pay For Performance
If you say whether you choose miles, points, or cash back, they are all free when you only signed up for a credit card or charged purchases you would’ve made anyway, you have to remember not paying cash doesn’t make something free. If I offer people lunch on the condition that they weed my yard, I don’t suppose they will rave about how they are getting lunch for free. They have to do the specific things I dictate. The gym in my office building isn’t free. I have to work for the privilege. As soon as I stop working here they won’t let me work out there any more. Miles and points work the same way. You have to do specific things to earn them. They are not free.
Banks aren’t charities. They know what helps them make money. If offering miles and points doesn’t achieve their business goal of making more money they wouldn’t be doing it. They want you to think you are beating them at their game. In this day and age of artificial intelligence, machine learning, and big data, you think they can’t figure out you never carry a balance? As Warren Buffett said, if you’ve been playing poker for half an hour and you still don’t know who the patsy is, you’re the patsy. You get miles and points only because you deliver profits to the banks. It’s that simple.
Think “Included”
So why do people say they are getting free flights and hotel nights when they have to pay with miles and points and those miles and points are clearly not free? Because the word “free” occupies a special place in our mind. It instantly appeals to people’s unrealistic desire of getting something for nothing. They want you to do the specific things they want. I forget where I read every time you see the word “free” you should immediately translate it as “included.” Although you don’t pay for it separately, you still pay one way or another.
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Jb82 says
One way to look at it. Of course you could also say that cashback is also free and you are just choosing your free gift. Then again nothing is ever free since even a prize could be sold for cash (plus you have to pay taxes on the prize usually!)
Usually though you are still getting a much better deal out of using points. You get at least part of the trip for free since the whole is discounted.
Dr-In-Debt says
Excellent points!
I get into this debate all the time with colleagues when they are bragging in the doctor’s lounge about the great free trip they took.
A major point that I’m sure you have covered before is that people tend to spend more when they use credit instead of cash. So all those free flights and free nights can end up costing you more than free.
We do a complicated split between cash back and travel reward cards to maximize the rewards for each. We tend to go to the same cities and towns and know which hotels and flights programs work best to minimize wastage.
Jen says
I get the point of this article. But my thoughts are this: I’m going to go on vacation regardless of whether I pay cash or use points. I might as well use points that I earned by charging something (and not carrying a balance). So I save my cash for other things like groceries.
Now if you are only going on vacation because you have points and otherwise couldn’t afford vacation, a cash back card would be a smarter financial decision for your household.
I will continue to enjoy our free hotels/vacations ? (Even with a few fees tacked on)
Dan M. says
Two comments: 1) You are describing the economic concept of opportunity cost which is the cost of giving up one thing to do another (I.e., the opportunity). So when you give up a 2% cash rebate credit card for an airline mikes card, the rewards you get in mileage rewards must be greater than the 2% cash rebate given up (I.e., the lost opportunity). There’s nothing inherently wrong with giving up one thing for another. The key is analyzing what you are actually giving up for something else and making sure you are choosing the option that provides the best value to you.; 2) Based on the analysis in #1, I believe obtaining two Chase Southwest Credit cards offering a 50-60k mileage bonuses, and thereby obtaining a Southwest Companion Pass which allows a person to fly free along with the person paying in mileage rewards (each actually pay $11 per round trip, which is virtually “free” since this is the flat cost per segment of any distance), offers the best value proposition of any credit card on the market — as long as the purchased lives close to an airport services by Southwest.
Dan M. says
purchaser, not purchased, in the last sentence.
Chris says
Regarding the gym in your office, I would think of that as having no incremental cost. I suspect its existence would be a very small part of your decision to work there.
I’m not a miles user but don’t some programs allow redemption of miles for more than their “cash” value?
lynnenyc says
I do the occasional new credit card for signup bonus miles, but have cut way back on that. I suspected that sometimes I was giving myself permission to buy things that I might have otherwise considered a ‘want’ versus a ‘need’ if I weren’t trying to qualify for bonus. And I time those bonus periods for when I know I’ll have some large but necessary expenses I can put on the card like replacing phone or laptop, bathroom remodel, etc.
I’ve also switched to cash back rather than miles on most of my credit cards. With the airlines making their mileage programs less generous, I’m less inclined to hoard miles unless I have a specific big trip coming up.
Leigh says
Yup, this. I count credit card rewards as “income” for this reason. I try my best to not spend “points” in a way I wouldn’t spend “cash”. Where it doesn’t reduce the point valuation, I always redeem my points for cash, rather than stuff, e.g. with my Amazon visa. With travel points, I count the value of buying the flight or hotel night in cash as “income” and the the same amount as travel “spending”. Points are not free money – they has a valuation and I don’t want to inflate my lifestyle using points to buy something I wouldn’t otherwise.
always_gone says
Reward travel is already baked into the price of tickets. The proof of this is in the fact that if I buy airline tickets with cash and don’t join the mileage program, I don’t get a discount on ticket prices. People might as well use their reward points because they’ve already been paid for with inflated ticket prices.
I’ll bet this is true for the costs of many items, now that so many people pay with credit cards. Prices are inflated to cover the cost of using a credit card (2% maybe?) so even cash back isn’t free because we are all paying more for the use of credit cards with purchases, right?
Harry Sit says
All costs, direct or indirect, must be baked into prices to leave a profit for the business. To the extent that the cash handling cost is higher than the credit card processing fee, customers paying with credit cards are paying part of the cash handling cost in addition to the credit card processing fee.
MT2 says
My “two cents worth” (that’s about the conver$ion rate for redeeming points earned on a credit card rewards plan): 1) Hotel room points earned are much more flexible than airline points, especially when it comes time to redeem; 2) Use your credit card for EVERYTHING you pay for;
3) Never do Step2 above unless you can stick to a monthly home budget; 4) always pay off your entire credit card balance at the end of the month.
If you can do this, you can enjoy something for nothing (well, actually more like $80 annual credit card membership to get 3-4 hotel nights for “free”)
b_bueeed says
Many times its employees reimbursed for travel through their employer for these points so are they “free” then to somebody? On a no fee card say?
Harry Sit says
The miles and points hardly compensate for time away from home when traveling on business. Employees pay through suffering. Not free.
Chris says
Harry, while I concur that business travel is burden, your compensation is whatever you get from your employer or customer. You would do that whether or not you got miles, because you choose to keep that job. Therefore the miles are, in effect, free. If it costs you annual fees or higher prices, yes, that’s a cost. But the annoyance of travel is independent of the points.
Harry Sit says
Letting employees keep the miles is part of the compensation given by the employer. Otherwise it affects the employees’ willingness to travel for business. Some companies actually keep the miles to themselves.
https://www.quora.com/In-firms-that-require-business-travel-do-the-employees-get-to-use-the-sky-miles-frequent-flyer-miles-they-earn-for-personal-travel
Don says
The points for my business travel are, to me, totally free. I wouldn’t consider turning down a job if the company kept the travel points, and I wouldn’t consider accepting a lesser job just because a company let me keep them. If the jobs were absolutely equal in every way (comp, work env, access to advancement, all other benefits, etc), and that’s assuming there’s a way to even evaluate these objectively prior to accepting said position, then yes, if that was the only difference between the 2, then I’d go to the one that gave me the points. The chances of this being the case would seem to be akin to getting hit by lightning 5x.
Harry Sit says
It’s all part of the total compensation, however small, whether monetary or non-monetary. I wouldn’t leave or turn down a job if they pay me $500 less and the chances of two jobs being absolutely equal in every way except $500 is also small. It still doesn’t mean that my last $500 in pay is free to me. I worked for it.
b_bueeed says
Still a valid point Harry- bringing in the emotional side of business travel as a cost to families. Every cost can’t be counted in dollars and cents.
Saverocity says
Albert Einstein once wrote that you have to go through life thinking that everything is free, or that nothing is. It’s fine on a certain level to state that nothing is free. That could be the opportunity cost on the airline mile, or it could be the 401(k) match from your employer (hey, it isn’t free because you could have not worked there).
But the reality is that miles and points, when used correctly, offer ‘free’ things. The free is the leverage between the opportunity cost of the cash, and the cost of the travel.
EG, if you could get 2% cashback per dollar, and you spend $10,000 in any given year, then your opportunity cost to do anything other than that is $200. Therefore, if you instead find that you earn airline miles, and you collected 10,000 of those over the year. If you need to fly from A-B and the cost of the flight is $180, you’d be better with the cash, but if you find the flight cost $250, then the miles offer a bargain – the $50 here is the ‘free’ part.
Now, compound this notion to take it to an extreme:
I just signed up for 3 credit cards:
$400 Annual Fee
$59 Annual Fee
$95 Annual Fee
I swiped each one once, for $5000 purchases, so a $15,000 transaction, costing me a loss of $300 in income, plus $554 in fees, I’m out of pocket $884 (this is the non free argument)
But in doing so, I earned:
$325 cash from card 1
65,000 pts valued at $975 when used for flights or hotels (card 1)
65,000 air miles, that can be cashed out at 1 cent a point (or more if used for travel) card 3
$600 in cash from card 2
So I’ve paid $884 to receive $925, and then I’ve got $975 towards flights or hotels, and 65,000 air miles…
It’s becoming harder to qualify the opportunity cost by this point. But then the next thing is that leverage again. The 65,000 air miles get me 1 way from NY to Tokyo in ANA First Class.. with maybe $150 in fees.
You could argue that the value of that is anything from the retail price (5 figures) to the minimum price (coach airfare) but even using the most lean valuation, it includes ‘free’. This ‘free’ upside grants us the ability to not just increase a net cash income, but also experience ‘free’ travel.
Harry Sit says
Did Einstein really say that? Many quotes attributed to Einstein weren’t said by Einstein.
https://www.quora.com/What-quotes-are-most-commonly-misattributed-to-Albert-Einstein
Next let’s be clear the 401(k) match is definitely not free. It’s just how employers structure the compensation of employees. You work for your salary, bonus, stock, 401(k) match, health plan, on-site gym, everything. The day you stop working, most of them go away.
Can miles and points have a higher value than their opportunity cost? Absolutely. Does that mean the difference is free? Suppose I have only two job offers, $80k/year from company A and $100k/year from company B. Is company B giving me $20k/year free? I doubt you will find many people thinking that way.
Company B determined that by having me as an employee and applying my time and skills to its business it will gain more than $100k a year. How much my time and skills are worth when applied to company A’s business is not that relevant. Every part of the $100k is contingent on my working for company B. I would take the offer but it’s not free.
The banks issuing your three cards determined that by having you as a cardholder they would gain more than the cash and miles and points that cost them. They can be wrong at the individual level, just like company B can be mistaken in hiring me. Whether they are right or wrong I don’t say part of my pay is free.
Saverocity says
He did not say it, I was using it as a play on words, but if we are to focus on accuracy, let’s skip the analogy and look at the specific case.
The arbitrage between the cost of acquiring the points (be it opportunity or real) and the redemption value is the upside. There clearly is real upside.
In the example I gave above for $15,000 (which I did last week) you can’t argue there isn’t something ‘free’ there. I pay $884, I earn that back, and more, and get points that can be used for travel.
There’s no way that isn’t free travel.
Harry Sit says
There’s an upside. It comes from your agreeing to become a customer. Although you don’t see yourself giving away anything the banks see it differently. Even by telling others you got free travel you become a word of mouth marketing ambassador for the banks. It helps them recruit their targets. You earn that upside. It’s not free.
FullTimeFinance says
While the opportunity cost of choosing flight rewards is not free, I agree with others that the choice is more between which free gift you choose. But… Free to you is different from free to the collective. Paying customers, those paying interest on cards, and regular prices reflecting transaction fees are all example of whom pays for your free reward. It’s a classic free rider situation where others subsidize those doing things like credit card sign up bonus. But .. that reality exists whether you participate or not. Your free rewards don’t directly decide the default card holders 20 percent interest. You along with thousands of others do
Harry Sit says
If banks make more money (higher revenue or lower cost) by giving the signup bonus or rewards from usage only to those who carry a balance and pay interest, they would’ve done so already. It’s their program. They get to set the rules. Nearly half of all active cardholders don’t carry a balance. Banks are well aware of that. They have all the data to know exactly who’s doing what. It’s not a free ride as banks would have you think.
Jacq says
I looked at my reward options the other day. I can save up more points, and get a $50 gift card or I can get ~$12.50-$20 now.
I’m not going to walk in with cash to pay my cable bill, the drive itself is inconvenient (30 min from where I live) so if I’m going to use a card, I may as well earn points I use for gift cards for Christmas or restaurants I go to occasionally.
I am targeting air miles on my other card to help with an up coming trip. I put end of year dental balance on that card. I would not feel comfortable walking into the dentists office with that amount of cash, and I don’t know how they would feel having it in the office. I put plenty in savings throughout the year to cover such expenses and using a credit card gives me the time to move $ from savings to pay it off in full.
Harry Sit says
I use my cards too. I just don’t ever think the miles and rewards are free.
Dads Dollars Debts says
I made a hilton reservation the other day, then they tried to share me on a time share. They said, “We will give you a room for a discounted rate for $8 a night in Hawaii”. Now that sounds amazing. The catch, “You have to listen to 2 hours of a tour and sales pitch!”. No way am I going to Hawaii to listen to a sales pitch. I value my time more than that savings.
Sookie Bush says
Harry,
“They have all the data to know exactly who’s doing what”.
I think you are giving the banks way too much credit. They may have the data, but most have no clue what to do with it. If they were so smart they wouldn’t have destroyed the economy. BOA stock price has still not even close to recovered. This is not to mention the complete lack of ethics from these institutions. They are run by morons who all should be in jail.
Harry Sit says
Destroying the economy, the stock price, and lack of ethics are getting a little off topic here. I just want to say it’s not a good starting point to underestimate your counterpart. See Warren Buffett quote about who’s the patsy. Assume it’s all deliberate until proven otherwise.
Sookie Bush says
Not off topic at all, just proving the incompetence of the banks. It has been proven otherwise, take a look at BOA’s stock price.
KD says
I believe you are mixing the macro-decisions with the micro-decisions. Banks are very good at product selling, marketing, getting customers and retaining them, and generating profits from them. Otherwise they wouldn’t have gotten so big with so many customers. It was their greed in profit making that they went on a limb on private investment for the banks themselves, mortgage selling binge to create more lucrative derivatives and were caught on the losing end of the derivatives trade unfolding after the market collapse. Subsequent laws that were passed limited banks ability to make risky investments and as their profits are expected to be more muted, so are the stock prices.
A word of wisdom: never bet against Harry. He is one of the sharpest analytical minds in personal finance.
Sookie Bush says
Banks are not very good at anything except theft and opening up fake accounts for customers. Actually the entire universe of investors are betting against Harry, look at the BOA stock price over the last 10 years.
Peter says
“Banks aren’t charities. They know what helps them make money. If offering miles and points doesn’t achieve their business goal of making more money they wouldn’t be doing it.”
Of course, they know. What is wrong with doing it? They give consumers incentives to use credit cards. Costs of incentives such as discounts, cash back, miles are passed through to merchants. If a consumer pays monthly balances in full, credit risk is small. Meanwhile, merchants pay about 3% on $$ volume of their credit card transactions and can’t get out of it. From airlines’ perspective, they’d rather offer one free ticket to a family then fly with empty seats.
No charities. Business only.
Harry Sit says
Nothing wrong, except some people think banks miscalculated and they are taking advantage of banks’ error similar to “Bank Error In Your Favor, Collect $200” in Monopoly.
Peter says
The article seems to imply that consumers are getting scr…d with banks’ credit card offers.
Harry Sit says
No, just they are not free. I gave other examples for not-free: layaway plan, food for weeding yard, and gym at work. The recipients are not necessarily scr…d. It’s a value exchange. They give something and they receive something. They don’t receive unless they also give. That makes it not free.
Stan says
Which card would you recommend to use?