I’m on a quest to determine a number of financial moves that will accelerate savings beyond the typical snail’s pace. I’ve written so far about opening a high-yield account, keeping your change creatively, and automatic your savings. These are all basic concepts that can be applied in interesting ways with a little bit of attention.
Many people disagreed with me when I railed against The Latte® Factor, David Bach’s trademark catchphrase and program which prescribes dropping your expensive morning coffee drink and depositing the value of each day’s savings into some sort of magical account that will return 10% annually after taxes and fees for forty years and end up with close to $1,000,000 more than you would have otherwise.
I’ll address my issues with David Bach’s program below. Nevertheless, a system similar to David Bach’s suggestion has merits for some people, thus I have a fourth tip for putting your savings in hyperdrive.
4. The Expensive Coffee-Related Drink Factor.
Obviously, I don’t want to call it The Latte® Factor, which is a registered trademark and a signature selling point that drives millions of dollars in books in seminars. Since I don’t drink coffee, I’ll use the therm ECRD to refer to any habit that requires a frequent expense but is easily controlled or replaced by another, less expensive habit. The savings from the elimination or switch can be accumulated and deposited into a high-yield savings account.
Problems With The ECRD Factor
It is important to remember that all of this is pointless if one doesn’t make smart decisions about the larger issues in life. You can forgo the daily coffee from Dunkin Donuts, but if you still eat two doughnuts every day, you’re spending money on something that you may pay for in health care costs later on. You can switch from premium gasoline to regular gasoline, but if you buy new cars every three years, the savings from the gasoline are ten or a hundred times lost by the unnecessary expense of buying new cars so frequently.
The scenario David Bach paints — an after-interest, after-fee, after-tax increase of almost $1,000,000 in 40 years from dropping your daily latte is an extremely unlikely scenario, both mathematically and behaviorally. Bach makes some serious assumptions that don’t have much validity in the “real world.”
- You probably won’t earn 10% in an account for forty years after taxes and fees.
- To invest in an account that earns even 8% over forty years, you will lose a lot of your money due to transaction fees. A $4 transaction fee, like the one charged by ShareBuilder, on a $150/month investment is a 2.7% fee right off the top. That’s not a wise investment.
- Without your daily dose of caffeine, you may miss out on career opportunities while asleep at your desk. This sounds like a stretch, but if you quit cold turkey, you could see adverse effects in your productivity and you may miss an opportunity without knowing it.
- It’s also quite possible that you enjoy your latte, understand the consequences and future savings you are giving up, and have decided your enjoyment is worth the potential loss.
So The ECRD Factor can have mixed results when you deal with variables in the real world. Don’t expect the kind of wonderful returns David Bach promises, but the frequent expense reduction or elimination that forms the basis of this tip can be a significant part of your saving strategy if the rest of your financial decisions are sound.
Making The ECRD Factor Work
What’s your ECRD? It’s probably best to pick something to which you do not have a physical addiction without appropriate support. While I would always suggest eliminating an addiction to heroin or alcohol, there are more immediate concerns in these cases than saving money, namely staying alive and healthy. It’s best to choose a daily expense that can be eliminated or replaced immediately without any significant withdrawal symptoms. The daily coffee-related drink might be a good candidate, particularly if you buy such drink from an expensive store like Starbucks. The good news is you won’t go through withdrawal if you simply replace the expensive drink with your own freshly brewed concoction.
And if you eliminate the drink entirely over the span of a few weeks, or replace it with water, you will get used to the change in chemicals in your brain within a few weeks.
Caffeine isn’t the only option. A coworker of mine has stopped buying lunch every day, opting to bring in a homemade sandwich instead. If not lunch, I know someone who used to eat out at an expensive steak restaurant every week. If you work in New York City, there’s the temptation to go out to the bar for happy hour with your coworkers. Do you smoke? Slowly cutting back will improve your health and save you thousands of dollars even before interest.
How about the news stand in the morning? If you pick up a newspaper on the way to the office to read on the train, consider this your ECRD. Replace the newspaper with a free news podcast if you already own an mp3 player. If you really like the newspaper, consider subscribing. You’ll save quite a bit off the newsstand price. The difference in price is your ECRD.
Apply Your Savings and Earn Positive Returns
If these are habits, cutting back (without affecting your networking experiences) and intentionally depositing the money you save will add up over the long term. It doesn’t have to be perfect. The three previous hyperdrive tips come in handy here. If you’re used to spending $4.50 in cash every morning for your latte and are ready to eliminate the drink entirely, put that $4.50 in your coin jar before you leave for work for later deposit into a high-yield savings account. Not a cash user? If you spend about $100 for your chosen ECRD a month, set up an automatic transfer from your checking to savings account for that amount. If your bank allows you to create separate goal-related accounts, like ING Direct’s subaccounts, create one specifically for your ECRD savings and transfer your monthly savings there.
Your high-yield savings account is not earning the 10% promised by David Bach. Forget about that rate and use the money saved for short-term goals. The more you save, the more you’ll also have available for long-term goals like retirement and legacy. So keep making good decisions all around — especially on the bigger expenses like real estate, vehicles, and education — and these seemingly small savings will add up over time. It starts off slowly, but compounding interest is the key to putting you savings in hyperdrive.
Image credit: Drab Makyo
Updated January 16, 2010 and originally published January 17, 2008.
{ 11 comments… read them below or add one }
“It’s also quite possible that you enjoy your latte, understand the consequences and future savings you are giving up, and have decided your enjoyment is worth the potential loss.”
I’m sorry, but I have to disagree. I would argue that a majority of people do not “understand the consequences and future savings they are giving up”. I think a majority of people look at their ECRD and think, “It’s only $4, no big deal, what’s $4 anyway.”
I know I’ve done it before walking through Target. “Oh, this thing is only $1, no biggie, what’s $1 anyway?”
Unless you are in/taking control of your finances and have learned about FVM calculations and have done a few on your own finances, there is no way you can assess what that $4 means for your future as you spend it day-in and day-out.
As far as DB, he’s not my messiah so I’m not going to get all bent-out-of-shape. I agree that his return is stretching it, but pumping up the return by a couple of percent makes the numbers grow much bigger which has much more impact with his readers. People who don’t understand FVM suddenly start to “see the light”. Compounding rocks!
Also, your points against his Latte Factor can all be overcome. If you use your LF savings to fund a Roth IRA that is invested in low-cost mutual funds, you can avoid most taxes and fees which may get you closer to the 10% annual return. By pointing out that Sharebuilder costs $4 you are ignoring all the investments that can earn similar returns but are free of transaction costs.
Lack of caffeine causing you to miss the opportunity of a lifetime? You’re pretty desperate here, aren’t you? The universe would really have to have it in for you to make that occur while you are on caffeine withdrawal.
At the end of the day, you have to admit that ECRD and LF are not that far apart. While David’s 10% return is a stretch, it’s not impossible. Everything else you both pretty much agree on.
-Toby
Thanks for your excellent observations, Toby. The ECRD Factor is the same as the Latte Factor®. I changed the name because I don’t want to use someone else’s brand and I don’t particularly like coffee. I think the article shows that I’ve come around to agree with Bach in many instances. The last sentence in the “Problems With The ECRD Factor” explain my stance.
I completely agree that “a majority of people” do not understand the future value consequences of thier purchasing decisions, and that point wasn’t meant to apply to a majority. I don’t believe that everyone is average or below, either. So much “financial advise” is doled out by authors to apply to the “lowest common denominator” in intelligence and fortitude in order to sell more books and be relevant to the most amount of people. I don’t think everything has to be dumbed down and I give readers more (metaphorical) credit.
A Roth IRA is a good choice for long-term investing built on savings from elimination or reduction of an expensive habit. Finding tax advantaged accounts once the Roth IRA is maxed out can be troublesome. If the 401(k) is available and not maxed out, you could increase your contributions there as a result of reductions elsewhere. If it’s an emergency you’d prefer to fund, then a high-yield savings account is a good choice. And my goal with the article is to tie these tips into everyday saving, so I’m focusing on more of the latter.
Great comments, Toby, I really appreciate it.
Flexo,
I appreciate you sharp eye towards suggested returns that people suggest. People shouldn’t expecting something that is not attainable. However, over the last century the stock market has returned and average of 11% – with some really bad and really good stretches built in.
That said, I don’t think the 10% DB suggests is stretching it if it were in an index fund. Tying Toby’s comment with yours and DB – if one invested everything into a Roth IRA for the 40 years that DB suggests, there would be no need to look elsewhere to invest because you would never be investing more than the annual limit each year. It could all be invested in the IRA – (of course, assuming that the ROTH stays in place for 40 years)
Flexo, your article matched an internal dialog I had while reading “Smart Couples Finish Rich”, written by Bach (Latte factor guy…insert the “R” symbol mentally there)
I think the purpose of the ECRD is just to realize that you can nickel-and-dime yourself and have a more carefree day-to-day experience, or you can nickel-and-dime into your savings and it will have large positive effect. Sure, the 10% is a stretch but that is forgivable in the same way that assuming all coffee is $4 is forgivable: they’re out-of-the-air numbers that are relatively reasonable, and serve to highlight the point that by giving up stuff that isn’t *that* important to you can give you the freedom to achieve things that *are* important to you.
That’s where I would put the emphasis. It isn’t the coffee part that’s expensive, and your point is DEAD ON that if coffee is important and enjoyable to you, then choosing it as your ECRD object to forego is a stupid decision. In my case, I drink the free coffee at work so this didn’t affect me. But I try to pack my lunch more often even though in SF there are 40 restaurants within a block of my office.
I also agree with the final weak point you highlight, that giving up an ECRD but not following larger financial goals is futile. There is a danger that a person could walk past Starbucks every morning and feel like they were prepared for their future since they didn’t fall for the ECRD.
People always focus on Bach’s ECRD/LF, even though I think his more important advice is to keep track of your expenses for two weeks, add it all up, and if you are shocked by some of the items (which you probably will be), then correct your behavior regarding those items. His guess is that most people will be shocked at how much they spend on coffee. I was shocked to see how much I spent on work lunches. Find out where your money is going, and fix it if you’re not happy.
On a final tertiary note, caffeine is DEFINITELY not a drug to go cold turkey on. Almost unanimously, doctors say to gradually reduce your intake by a drink every three to four days.
Sorry for the long comment!
@ChristianPF
I personally plan on saving more than $4k per year for retirement (the Roth annual limit).
Also, I hope to make more than $101,000 per year sometime before I turn 60. That is the salary limit for Roth IRA; if you make more than that you can’t contribute the full $4k, and if you make $116k or more you can’t contribute at all.
The Roth IRA is awesome. Since I’m young and under the salary cap, I will max it out this year. But thinking that you’ll only need to save $4k per year seems naive, and thinking that everyone will make less than $100k per year for the rest of their lives is depressing.
On a purely practical note, I’ve found a successful way to cut down on my ERCDs.
I give myself a budget a week (say $50, less than what I was spending originally) so I can have the occasional coffee or work lunch (to be social mainly). Any amount leftover, I use to buy myself a little something something which gives me incentive to use as little as possible.
It is working a treat! Working in a little pleasure fat goes a long way in keeping me on that wagon in a way that righteous deprivation never will!
Maxine: That’s a great idea! Thank you for sharing.
Flexo, I agree with you a great deal. there are people who do not buy that daily coffee or daily lunch or anything else. The latte factor doesn’t work for someone who is already budgeting to the penny.
We have to be more creative.
@Brian
I agree, me too – but according to DB’s plan, you won’t need to if you save the $4 a day for 40 years. If you followed that plan you would never hit the IRA max contribution for a given year.
Here’s a thought…make your own coffee and take it with you! :) Great article!!
I enjoy subscribing and reading your stuff.
Re : “replace the newspaper with a free news podcast” – my son-in-law works for the newspaper. Since I’d like for him and my daughter to be financially stable, I hope most people don’t follow this advice. How about “subscribe to the newspaper and have it delivered to your home for less than 1/2 the price.”