When Lattes Are NOT Your Problem
|September 14, 2012||Posted by Roshawn Watson under Personal Finance|
People sometimes get so overwhelmed that they don’t know where to start with investing for retirement, especially while trying to simultaneously invest for a college education for children, pay for adequate insurance, and pay off their homes. This is where the Latte Factor comes into play. It is deceptively simple. By siphoning money designated for a seemingly inconsequential daily indulgence into investments, a latte, you can jumpstart your retirement savings and win financially.
Personal finance author, David Bach, famously illustrated his concept with the following scenario: by investing the amount that you would pay for a latte and a muffin (ie, $5/day*30 days/month=$150/month), you could amass an impressive $948,611 over 40 years (assuming an aggressive 10% annual return). That’s substantial, especially considering that 51% of households risk being unable to maintain at their pre-retirement standards of living at 65. Nonetheless, the Latte Factor has been surprisingly maligned over the years, but it typically has little to do with the math.
While conceptually sound, the Latte Factor may have overstated the power of forsaking caffeinated delight. The overwhelming consensus is that sometimes lattes (or your ” latte” equivalents) are NOT your problem.
The Biggies Are Out of Control
Don’t be penny-wise but pound foolish.
Many people expend an inordinate deal of time and effort finding ways to save a little money. The wisdom for doing so is clear: small leaks sink big ships. However, I always wonder what would happen if we would devote a similar amount of effort in trimming some of the larger expenses instead. After all, according to the Law of Parsimony, sometimes it is easier to sale 50,000 books one time than sale 1 book 50,000 times. For example, housing is typically Americans’ biggest expense followed by transportation, according to the Bureau of Labor and Statistics. Today, housing and transportation comprise of more than half of American household income. That’s because sixty percent of Americans are homeowners, and higher rent costs, particularly in coastal cities, constrictive urban policies, and a shortage of multifamily homes all contribute to an acute rise in housing expenditures for non-homeowners. Unfortunately, housing alone can be as high as an untenable >40-50% of income for some.
Similarly, many families drive themselves straight to the poor house. Buying a vehicle is more than simply a means of transportation: cars are emotional purchases. America has a long-documented and complex love affair with our vehicles. Basing vehicle purchases solely on dollars and cents simply won’t do for many.
Related Article: Why Do We Save Anyway?
However, if the same effort was put into significantly reducing housing and driving costs ( large expenses) that was put into saving on the small budgetary items, many could afford more small luxuries AND hit their financial goals. Money Magazine writer, Walter Upgrave, indicated that driving less expensive cars (such as Honda Accord versus Acura) during a lifetime could save one $180,000; sending your child to a public university could result in $164,000 in lifetime savings relative to private school costs; and cutting vacation spending by $1,000 a year could yield an extra $122,000. For some of us, the savings could be much more.
That’s the reason most millionaires live relatively more frugally (particularly in terms of housing and driving) than even the typical American households. Doing so allows them to invest more aggressively and gain greater control over their destinies.
Related Article: Why The Rich Get Richer
Don’t be penny-wise but pound foolish. It is important to gain control of the “biggies” too.
Suppose You Like Lattes
One of the biggest criticism of the Latte Factor has little to do with its impact on your finances. The issue is some apply the Latte Factor indiscriminately; thus, they use it to deprive themselves things that they really enjoy for the greater good. While such deep sacrifice is laudable and some sacrifice IS necessary, using the Latte Factor to cut things that you really value is not really the intention. If your daily latte (whatever a “latte” means to you) brings you significant joy, foregoing it may be too much sacrifice. It is hard to have a serious budget with longevity if it is so restrictive that you never have any fun (more on this next week). Never forget, why you save in the first place.
Related Article: Broke People Afford Everything
The Latte Factor is concerned with eliminating frivolous and/or unconscious frequent spending. Most of us have such spending, even if it has nothing to do with Starbucks, such as habitual spending on eating out for lunch, smoking, magazine and newspaper subscriptions that no longer engage us regularly, or even the rarely used gym membership. Trent, from The Simple Dollar, suggested that perhaps suggested changing the Latte Factor to the Detergent Factor to reflect how you can save $10 in 10 minutes by making your own detergent to reflect that the purpose is to focus on “luxuries” that you wouldn’t miss. The purpose of the Latte Factor isn’t to eliminate Starbucks (or Tide detergent) from your life but to highlight that there is some fat that you can likely trim almost painlessly, and that the value of that money of over time can be substantial if properly invested. Thus, consider cutting the frivolous and/or unconscious spending.
The problem isn’t having it all… it is having it all at once.
Walter Upgrave said it this way “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.”
Income is Simply Too Low
Another situation of when the Latte Factor doesn’t apply is when there is a serious income deficiency. In this scenario, one’s expenses are reasonable and his budget excludes luxuries, yet his income can not cover the living expenses. People in this situation have no lattes to cut, spend almost exclusively on necessities (food, shelter, transportation, utilities), and struggle to tread water.
This is why caution is needed in telling OTHER people to simply cut deeper, as if reducing expenditures is a cure all. Cost-cutting advice will likely only serve to frustrate those in this situation, as unreasonable expenses are not their problem in the first place.Sometimes the budget has already been cut to the bone. Increased income generation, rather than cost-containment, is needed, which is a different beast entirely.
Clearly, the Latte Factor is about more than just coffee. Eliminating the fat in our budgets is worthwhile. Expenses that once made sense may no longer be reasonable or worthwhile for us. The Latte Factor does stimulate such examination, which is valuable. Additionally, it provides a needed rebuttal to people who argue that they can’t save anything, yet somehow they afford everything but saving and investing. However, sometimes it simply may not be directly applicable to your situation at all. Financial maturity is knowing when concepts are to be applied literally or figuratively and knowing their assumptions and limitations. Sometimes lattes are simply NOT your problem.
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