The concept of the Latte Factor is one of the most divisive issues in personal finance. Money gurus get so worked up over whether the Latte Factor is a valuable lesson in money management that one might think the issue were as important as war, the national debt, or capital punishment. Most of the time, passionate responses pertaining the the Latte Factor is based more on book sales and pageviews than any rational consideration of the issue.

The Latte Factor, a term coined and trademarked by financial author and guru David Bach, posits that small, repeated savings, of which people can make habits, can aid the growth of wealth over time. The math bears this out to be true: Assume you spend five dollars every weekday on a fancy coffee-related drink on the way to your office. If you cut out the coffee or replace it with a $1.50 less-fancy drink, you save at least $20 a week or maybe a $1,000 a year. Put that money in a bank or invest it, and assume you can earn a return from interest, dividends, or investment gains, and over the next ten years you’ll have $11,000 to $16,000 more to your name than you would have, had you continued buying your daily gourmet drink.

This concept isn’t limited to expensive coffee-related drinks. Any habits that result in spending money that could be deemed unnecessary can qualify for elimination due to the Latte Factor. Cook your own food rather than dine out once a week, and you could save just as much money or more over the same period.

Most people, however, don’t bridge the gulf between reducing spending in one area and increasing savings with the difference. Unless there’s a concerted, conscious effort to transfer money from a checking account to a savings account or an investment, the money formerly spent on lattes or other repeatable expense will just be spent on something else.

Furthermore, families that have already reduced their spending due to tough economic conditions that have become personally relevant may not have much room left to scrape the barrel to find additional savings.

Yet another criticism of the Latte Factor is that it minimizes the importance of reducing large expenses. If a family gets into the habit of saving money ordinarily spent on lattes and uses that attitude to justify buying a more expensive car, all the work will have been for nothing.

Well — the work would have been for a more expensive car. All spending is a choice. It’s easy to remember this when a friend refuses to spend time with you, citing the expense of the activity, while they continue to purchase unnecessary electronics equipment, for example. You can identify someone’s priorities by looking at how they choose to spend the money they have and the time they have available. If you look at your own priorities, your budget should match.

Whether you realize it or not, you’re broadcasting your priorities to the world, but mostly to yourself, by spending money and time in one area of your life at the expense of another area. If there’s incongruence between the priorities you think you should have and how you spend your time and money, consider changing something or accepting the idea that your priorities may not be what you expect. Your real priorities are evidenced by how you spend your limited resources.

If the pick-me-up and self-esteem you receive by drinking a latte in the morning is important to you, and you realize your habit results in a hypothetical “loss” of $10,000 or more over the course of ten years, spend the money. Buying a practical car that requires little care, uses fuel efficiently, and will last a long time can save money over the course of several decades, but if buying a less practical car makes you feel happy and won’t be a financial hardship, even if it means leasing a new car every three years, then go ahead. Your spending reflects your priorities.

I see this in my own spending. I still drive my old Honda Civic. In one respect, I haven’t purchased a new car because I see it as an unnecessary expense and I’m comfortable with keeping the money I would need to buy a new car in my savings account. Meanwhile, I spend money on things other people would see as frivolous, such as photography classes and equipment, hiring a maid service for my apartment on a bi-weekly schedule, coin collecting (though not much recently), and travel.

Is the Latte Factor relevant to your personal finance experience? What does your spending say about your priorities? Relevant responses to this article are worth twice as many points as usual. If you are a registered Consumerism Commentary visitor, you can earn points by participating in discussions to redeem for Amazon.com gift cards.

Photo: RaeAllen

{ 5 comments }