Forget About the Latte Factor
See also: Put Your Savings Into Hyperdrive, Part 4: The Expensive Coffee-Related Drink Factor.
I’m sure a number of regular Consumerism Commentary readers have heard about “The Latte Factor®,” the idea (trademarked by David Bach) that cutting back on a cup of gourmet coffee each day will result in wealth in the long term. My position on advice like this is it’s penny wise but often pound foolish. It’s the bigger things that count more. Walter Updegrave from Money Magazine holds a similar opinion.
Instead of obsessing over every little treat, try adopting a more realistic savings strategy. Start by acknowledging that funding retirement involves compromises. You are probably going to have to give up something today for a shot at a better tomorrow. But by going about it the right way, you can often find tradeoffs that will allow you to sock away real money while still leading a rich, full life.
In Bach’s example someone who cuts back on one coffee a day will save almost $1,000,000 after 40 years, assuming an unrealistic 10% return after fees and taxes. With a more realistic return, you’d be looking at much less, more likely around $400,000.
Rather than the small stuff, Updegrave believes it makes more sense to focus on the larger expense items throughout one’s life. Not only is Bach’s 10% return unrealistic, but the idea of reducing caffeine intake every day is a lot of work. A decision every day for the rest of your life is more difficult to manage than a few important decisions throughout a career. Here are Updegrave’s suggestions:
- Drive less expensive cars, save $180,000.
- Send your child to a public (not private) university, save $164,000.
- Cut your vacation spending by $1,000 a year, save $122,000.
Updegrave makes some assumptions as well, most notably:
- You drive expensive cars.
- You have a child and will pay for his or her education.
- You take vacations.
So obviously, this plan doesn’t work for everyone. But if it works for you, that’s more than $450,000 you’ll save before interest or returns. Invested, that will put you well ahead of Bach’s number — if all three suggestions are implemented and net the results Updegrave predicts.
Personally, I don’t even drink coffee. But maybe cutting back on the joe and saving the money instead works for you. it’s not a bad idea if you’re dedicated to the plan, and making the savings automatic will help, but after a while, I’ll bet many people are back to Starbucks despite the automatic savings.
Article comments
I think that both of these men make great points.
There are many people whose small purchases are killing them just as there are many whose largest purchases are killing them financially.
For instance, one of the worst drains of money for many people is cigarette smoking. For instance, a half pack a day smoker in my state (Florida) is wasting $7 every other day on a pack of branded cigarettes. The biggest problem of smoking is the other costs such as more expensive life insurance rates, possibly more expensive health insurance rates and other costs which are harder to quantify.
The every other a day pack over the year may save somebody over $100/month. $100 could feed a person for a week or buy 25-30 gallons of gas. Otehr expenses that it could pay for are cable and internet access together, cell phone bill, or a utility bill.
On the other hand, how many people buy a car that is bigger than their needs. When the large gas-guzzling SUV’s, how many people bought them and had no real need for them. Yes, gasoline was cheaper, however, with gas prices high now, it cost more to own. In addition, the insurance costs are higher.
I think it’s question of quality of life and continually editing. If the latte is instead of something more expensive, like going out for a meal, then it’s cheaper. If you’re self-employed and it gets you out of the house instead of going shopping for a distraction, maybe it’s a net winner. I share a Duetta creditcard with my teenage daughter – it’s a free credit card, and the bonus points go towards Starbucks. I guess that’s having your latte and drinking it too.
Bigbuddha: Thanks for stopping by and commenting. I’m just wondering what index and data are used to come up with an average of 15%+. This is the first I’ve seen a figure that high for long term investing in any market.
I suppose an average that high is possible if you buy at a market low (after the crash/Great Depression) and sell high… but that involves market timing which is unlikely to happen. 8% is much mor realistic for an equities market over the long term… in fact it might be too high taking into account the economic advances in the United States over the last two centuries… some believe we’re unlikely to see progress like that in this country again.
10% … why is that unrealistic? The share market index has returned an average of 15%+ historically … and thats just the all ords …
I’d do alittle more looking into it before making such a broad sweeping statement like 10% is unrealistic …
then again I’ll never shy from being proven wrong.
I think we should only cut down what’s not important to us: retirmement is important, sending kids to college, owning a house, having reliable transportion — most people might think those things are all important. The problem is, as it is with all economics, limited resources: how can you get to all of those goals if you don’t give up something? I don’t have a good answer to that, but, I guess, giving up some things is better than giving up others. For some, it’s the daily vices that really add up (and, losing them may provide a healthier life). Others don’t want to quit coffee or cigarettes or drinking or whatever, it’s part of their pleasure in life. But for some, pleasure also consists in having a fantastic first class expensive vacation. Or a “done” home. It is all choices, and, no one person can decide what is right for another. I will say this: if you don’t decide, you will not have the ability to decide, i.e., if you don’t start investing for retirement, you will not have a choice about what kind of retirement you will have. And if you put all this instant gratification type shopping things on credit, you won’t be able to afford nice cars or lattes. Make choices.
I am currently quitting caffeine and it isn’t as hard as people make it sound. Just reduce your intake gradually over a few weeks, replacing it with something healthier like water or herbal tea.
I also quit smoking, quit junk food, drastically reduced eating out, and more, and all that stuff really adds up (about $20,000 a year in total). That’s big money. And if you put your mind to it, quitting these additions isn’t that hard.
Check out my post on this:
How I Save Money
Stopping or limiting vacations is where I draw the line and get off the train…
What’s it all for if LIFE can not be enjoyed?
Some of this stuff is simply getting far to micro for me to enjoy. I guess I manage my finances well, so many of these articles are not directed at me, but there needs to be a limit. Enjoy the coffee…Enjoy the PRE-OWNED Lexus, enjoy a trip to Ireland, just don’t go over-board with it.
You’re definitely on to something here.
I wrote about this phenomenon myself on my blog a few months back
[…]Flexo over at Consumerism Commentary instigates an interesting discussion with the post titled Forget About the Latte Factor. Not only is the article interesting, it is followed by a fantastic discussion in the comments sections. Check it out.[…]
As someone who earns minimum wage, I note that this is all pretty much useless to some of us. I can’t afford a car. I can’t afford to have kids. I can’t afford to take vacations. I have never even bought a latte or even a cup of plain coffee.
I definitely agree with Updegrave. It also follows the idea of MSN 60% solution which says it’s your committed expenses that kill you. It is so tough because when people buy too much house they are unable to save anything. So I guess it isn’t just the lattes.
I agree that habits and mindsets contribute to long term success… but one poor large decision can eliminate any gains from a lifetime of smart small habits.
My husband and I both work in downtown in a major city. Even a quick sandwich and a soda brought back to eat at your desk costs at least $7. So between the 2 of us we were spending $280 a month ($3,360 a year) on lunches. That’s about equivalent to what we’re socking away for one child’s college education! (and we have 2)
So I started making the sandwiches and packing lunches the night before, which is a major pain that I would love to give up. But I figure I’m saving us $10 a day, including the cost of food from the grocery store, so I am committed. That $10 is $2,400 a year, better off in my pocket (or a college fund).
Also, I buy my diet soda (I know, I know, bad for me and my teeth) on sale by the case at a downtown drugstore, and lug them back to the office instead of buying them from the office vending machine. This saves another $120 a year ($0.25 or less versus $0.75), and is the exact same soda.
The sandwiches aren’t bad, and this way when I do go out for an occasional pricey lunch, it’s a real treat.
I absolutely believe that our regular habits count the most when it comes to managing money over a lifetime.
I don’t view this as an “either/or” issue. Big things have the potential for bigger savings – as an example we do not own a car which is a huge saving. Small things can also be important. My first savings came from controlling small expenses as a student and when I first started working for a low salary – at the time saving money in small ways was the only way to save money because there were no large expenses to cut back on.
All cost savings ultimately add up.
One big smart decision can save you a bulk, I agree with you there, but 10 small foolish things can keep bleeding you into agony. So yeah it’s a smart thing not to waste those 3 bucks in the daily coffee…or whatever other habitual expense that you are into.
Having said that, I simply brush off the “convert $3 in $1 million” advice that follows the “stop spending” advice. I just pretend it’s for inspiration. Most of such schemes sound pretty stretched out from reality. Sometimes, these stupid schemes take the charm away from the main advice: “spend money smartly”.
Kevin, the problem is that inflation eats way the 10% each year. You might make 10%, but if everything costs 4% more, have you really made 10%? I say you made 6%. That 6% is then taxed when you take it out of your 401k. You might lose 1/4th of more of it after that. And of course there are fees in the 401k.
Yeah, it’s tax-free in your Roth, but you are limited with how much you do there. I already max that out, so when I save more money, I can’t put more into a Roth. When they make Roth’s without limits, I’ll buy into it being tax-free :-).
Thanks for the comments, everyone. Very interesting discussion. $4 a day is nothing, but it adds up over time. But when you’re concentrating on the little things without paying attention to the big decisions, you make poor choices that completely negate any gains you would have gotten by depriving yourself of your latte (or whatever) a day. I’m not speaking literally here… the latte as commeters above said represent any little change you can make.
You can’t focus on these little things and expect to be any better off in the long run if you don’t concentrate on the bigger decisions… regardless of whether you’re getting 6% or 10% on your anti-latte investment. Most people won’t invest the money they save from this endeavor, anyway.
Brian H: “Almost all the successful people you read about started small.” I’m not sure that this is a provable statement, but even if it is true, that doesn’t mean the Latte Factor is the solution. Start out small could easily mean starting out building a small business… which is how the successful people I know started. Lattes (or any other little expense) were not part of the equation.
Alex: Thanks for the link. It is a wow factor. People who read Bach’s theory are supposed to say, “Wow! I can save almost $1m by not drinking lattes!” And then they’ll buy his book. “Wow” sells books… just ask Tom Peters.
Stephanie: I agree that people can cut back, but buying things one doesn’t use is something different than buying a latte which presumably provides immediate sustenance and enjoyment.
I think everyone just has to take the idea of the Latte Factor and look at their own life. For example, no one in my family drinks coffee because we all have a caffeine allergy. But there are similar things that should be cut back.
For example, my mom needs to stop buying things just because they’re “on sale.” She bought this all-in-one record player, cd player, radio thing the other day, because we don’t have one anymore. But, for the 10 or so years we did have all of those things, she never used them! She bought it just because it was on sale!
So the whole point behind the latte factor – is to stop wasting money on the little things, right? I think the numbers are more ment to make a point – it’s more of the “wow” factor behind what you’re spending… and not really a life planning tool.
I did a post on this recently – and not only do I discount the premise of the latte factor, but I think that under certain circumstances that Latte might actually add-value to your life.
Here’s a link…
http://www.thealexblog.com/2006/11/06/beyond-the-latte-factor-look-at-the-income-side/
According to Jim Rohn, the philosophy of the rich versus the poor is this:
“The rich invest their money and spend what is left; the poor spend their money and invest what is left.”
This paragraph is the key to understanding how to put your financial house in order. Ignoring it will leave you in a sad place. Practicing it will propel you toward your goals.
You don’t have to invest all your money at once. You can start off with just a few dollars. And trust me, no matter how bad times may be, you will not miss a few dollars a week.
And if you think that a few dollars a week won’t add up to muchâ€â€?you’re wrong.
Almost all the successful people you read about started small. The famous actors that now make millions of dollars per movie, started working for free in community theaters. Then they moved up to getting paid a few bucks for bit parts in movies.
Many CEOs and presidents who make millions of dollars a year, started off in the mailroom working for minimum wage at the very same corporations they now run.
And almost all of the world’s richest investors started off making tiny investments at first. You can’t get to something big if you don’t start with something small.
So yes, even investing just a few dollars a week will open the door for you to soon start investing much more.
Small hinges swing big doors.
Of course, the Latte Factor is just an metaphor, not to be taken literally. Cut out some little luxuries and otherwise live a little beneath your means, and invest the extra money. You don’t really have to cut out the coffee. Just brew your own and save a bundle, vs. going to the coffee shop every morning.
I don’t think a 10% average annual return is unrealistic at all. Take that money and invest it in a broad market index in your 401K for 40 years could easily result in million dollars.
I ran the following example through a savings calculator: If you can find $6 a day to save instead of spend, and invest that $180 every month for 40 years at an average return of 10%, you’ll have just over $1,000,000. If you do this in a Roth IRA, it’s all tax free.
David Bach always works with the assumptions that his readers are in the 30% tax bracket and have a matched 401k, AND will get a 10% return on those 401k earnings. He doesn’t bother to speculate about the tax rate upon retirement either, so most of his numbers are just abstract hogwash.
For Updegrave, who can afford vacations? And while I know the cost of college is rising, it’s rising across all income levels. When I was in college a few years ago, it was a difference of about $70K between the state university and the private university, assuming no scholarship at all. And any attractive candidate will usually get some scholarship, provided he or she picks the right university.
The expensive car thing is on the level though. Enormous car loans seem to be the kiss of death around here. Even cheap cars that are stupidly financed are big money wasters.
I read an article on smartmoney earlier titled How to Save $150,000 (And Still Have a Life), which looked at a similar argument – i.e, dont sweat the small stuff. They outlined the following to save $150K over 10 years.
a) Save on mortgage by hunting for lowest possible interest rate. (Their calculted savings: $30K over 10 years)
b) Drive a used car. (Their calculted savings: $40K over 10 years, based on ‘cents per mile to own’ calculations)
c) Investing – Get rid of the fees (Their calculted savings: $25.5K over 10 years)
d) Insurance savings – choose term life, make use of the FSA, combine different insurances to get a discounted rate etc. (Their calculted savings: $42K over 10 years).
e) Then they have a list of 14 “bonus” tips to choose from to arrive at the round figure of $150K
Its an interesting read. Quite well-written.
The Latte Factor is nothing more than a buzz word. The problem with this idea is that it requires people to give up a physical addiction, caffine, in order to save for the long-term. Bach’s book is geared towards people who have little knowledge or discipline over their financial situation. Telling these people that the seceret to reitrement wealth is breaking a habit they face each and every day is overly optimistic, in my opinion.
Personally, I am a coffee drinker. I brew my coffee at home to save money. I do this because I am frugal and do not agree with Starbucks $4 coffee. I agree with Flexo and Updegrave that the focus should be on making intelligent decsions on life’s large purchases, like cars and homes. I would also add that many people should put effort into trying to INCREASE their income, through education or a part-time business, rather than trying to nickel and dime their addictions, that they most likely will not be able to stick with in the long run.
Just my thoughts…
A few comments:
First, I’ve seen the latte factor used more in reference to people who claim they can’t save anything, but they still drink their $3 cup of coffee every day.
Second, I think the latte factor (isn’t there a better term for this?) _does_ apply to retirement savings, but you can’t limit it to coffees. Basically one needs to look at all the “small” expenses that add up. It’s easy to do this. Track your expenses for a month, and then tally up the expenses that you list as “miscellaneous”.
For me, over the last couple months I haven’t been bringing my lunch to work. So I buy lunch in the cafe – that’s about $6. Then I buy a couple sodas from the vending machines. That’s another $3. On the way home, I might buy dinner at Subway ($8) instead of having a bowl of cereal. While picking my wife up at the airport last week I bought a magazine to read. That was another $6. These small expenses add up, and it’s not at all hard for them to hit hundreds of dollars per month.
Lastly, of course, he’s right. Buying expensive cars is a sure way to poverty. But I’d bet that a typical middle class consumer can save more money by cutting out small expenses than he can buy opting for the Explorer XLT instead of the Lariat.
I actually don’t think 10% average annual return is unrealistic over the long term. Even after taxes & fees.
That’s been the historical average of domestic stocks going back to the 1920’s (not including taxes/fees) and if you go with low-cost index funds and have the discipline to leave them alone, I think 10% is very realistic — again, over the long term.
I want to point out that Updegrave’s comment about higher education is often wrong. One big myth for college is that private education is more expensive than public – while tuition rates are typically higher, private intuitions often offer better financial aid terms and options. And, financial aid isn’t just something for lower income students/families. Schools often have additional incentive to draw in higher income students (families) with aid packages, especially when high income families are seen as a possible revenue/fundraising source.
I don’t generally agree with the Latte Factor in the literal sense as you mentioned, but as a coffee addict, it really can save a lot of money if you cut back.
I don’t drink the fancy coffee as it is, but even my large black regular coffee at starbucks or other coffee shop every morning would run between $1.49-$1.69. I used to stop every single day on my way to work, spending close to $10 each week. Over the course of a year, that is over $400.
Instead, I just bought a 12 dollar coffee maker for my office and every few months I spend $8 on a big bag of coffee. So instead of spending $8-10/week I spend that every two months.
You could compound that over 35 or 40 years and get some big six-figure number as to money you could save, but I agree that is unreasonable. What is more important is that the little bit of savings can be applied to everyday expenses.
If I can save $35-$40 a month by brewing my own coffee, I won’t invest it. But what does that savings cover? A cell phone bill? Gasoline for a few weeks? Cable TV? I’m not tucking the savings away to earn 8% over 30 years to grow my retirement account by over $100k, but without paying much attention to it, the savings is helping pay regular bills which in turn creates more money available for savings.
So I think the little things can and do add up and help, but when it is shown as illustrated by the likes of David Bach it is very unrealistic. It paints a fantastic picture, but in the end there are better ways to make more headway towards creating wealth which you outlined above.