In the world of miles and points, there are indirect and direct costs to accumulating points. In fact, you could head over to Air Canada's website and purchase Aeroplan points directly from them for 3.5 cents per point (CPP). But that doesn't mean you should. Savvy enthusiasts understand the importance of lowering the cost basis of points to maximize their value.
Understanding Cost Basis
In simple terms, the cost basis of points refers to the actual amount spent to acquire them. By minimizing this initial investment, you can increase your return on investment significantly. We calculate the cost basis of points using the following formula:
CPP = All Associated Fees ($) x 100 / Total Number of Points
For the purposes of this post, the costs that matter to us are annual fees and transaction fees when using card payment services.
Credit Card Sign-Up Bonuses
Credit card sign-up bonuses (SUB) serve as a lucrative avenue for accumulating a large number of points or miles in a short period. These bonuses typically require cardholders to meet a minimum spending requirement within a specified timeframe, in exchange for a generous reward of points, miles, or cash back. By strategically applying for credit cards with attractive sign-up bonuses and meeting the spending requirements, travelers can significantly reduce their cost basis for points.
Example
A credit card with an annual fee (AF) of $120 with a sign-up bonus of 50,000 points after spending $3,000 in the first three months. The card earns 1 point/$ on everything. So once you meet the minimum spend you have earned 53,000 points.
Here are some of the variables
Annual fee: $120 but you sign-up during a promotion period where they offer the first-year free.
Third-party payment service: You cannot meet the $3,000 minimum spend requirement organically so you use a service like PaySimply to pay your tuition with a 2.5% fee. (You would pay $2,927 with a 2.5% transaction fee of $73.18 to reach $3,000.18.)
Cost Basis (CPP) = (Annual Fee + Transaction Fees) x 100 / 53,000
Here is an example of CPP calculations based on the possible permutations.
Annual Fee | Transaction Fees | Cost Basis (CPP) |
Free | Organic (Free) | 0 |
Free | Payment Service (2.5%) | 0.14 |
Paid ($120) | Organic (Free) | 0.23 |
Paid ($120) | Payment Service (2.5%) | 0.36 |
Now, let's say you keep this card past the first year and continue to use this card as your sole credit card for the following year spending $1,o00/month on day-to-day expenses.
($120 + 0) x 100 / 12,000 = 1 CPP
The CPP calculated in the above example is your initial investment. By targeting SUBs, even if you churn the card once a year, the difference in your cost basis would be nearly 3-fold even for the worst-case scenario with a 0.36 CPP.
So What?
The cost basis calculation is important because it serves as the backdrop for how you will use your hard-earned points. Earning vs redeeming. The difference between these two values is what gives you your return on investment (ROI). I'll use the Aeroplan program as an example to illustrate:
At the time of writing this post, you could spend 79,900 Aeroplan points to buy yourself a DeLonghi Nespresso Gran Lattissima which costs $749.00 + tax, or you could spend 70,000 points + taxes and fees for a one-way business class ticket from Los Angeles to Frankfurt which usually goes for about $6,000.
For the redemption part, we also use the same formula to get the cost basis:
Nespresso machine $749.00 x 100 / 79,000 = 0.94 CPP
Business class ticket $6,000 x 100 / 70,000 = 8.47 CPP
Let's use 0.23 CPP and 1 CPP from the above example as our two cost bases to calculate our ROI using the formula:
ROI (%) = [(Redeem (CPP) - Earn (CPP)] / Earn (CPP) x 100%
Earn (CPP) / Cost | Item | Redeem (CPP) / Cost | ROI |
0.23 / $182 | Nespresso | 0.94 / $749 | 309% |
0.23 / $161 | Business Class | 8.57 / $6,000 | 3,626% |
1.00 / $790 | Nespresso | 0.94 /$749 | -6% |
1.00 /$700 | Business Class | 8.57 / $6,000 | 757% |
You can see there is a huge difference between each of these combinations. A 3,626% ROI is nothing to scoff at. So if you are going to play the game, your strategy should be to earn low, redeem high.
Air Canada Business Class from Calgary (YYC) to London, UK (LHR) booked with Aeroplan points.
Conclusion
Points are a valuable form of currency, akin to fiat money, but with a key distinction: the spending power of fiat currency typically remains relatively stable day-to-day, but the resulting value of points can vary greatly depending on how they're redeemed. Once the cost basis of points has been minimized through credit card sign-up bonuses, you can leverage them for luxurious travel experiences you wouldn't consider paying out-of-pocket for.
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