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.
Closing Thoughts
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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We are constantly reevaluating our budget. There are always tweaks we can make. I think our biggest saving grace is the fact that we keep good records. We use Quicken and track everything. This helps us actually see where we are spending money.
I tried Money as software, but now we just use Excel. I love how you guys make it a continual, iterative, and analytical process.
People has to start tacking the big problems first. If you buy too much house and car, cutting out the latte isn't going to help much. If you already have low housing and transportation expense, then maybe it's time to look at the latte. It's all about coming up with a budget that is sustainable in the long run. Increasing income is necessary too.
BINGO. nuff said 🙂
This is often missed.
I think the Latte factor serves to illustrate well the principle and influence of fractional increases in savings, particularly compared to not saving anything at all. But at the end of the day I like to Think BIG about my money. I prefer my own motto: Take care of the pounds and the pennies will take care of themselves!
Agreed. I'm not against the Latte Factor either, but I think in our zeal to simplify the nuts and bolts of personal finances we often miss the Big Picture.
I should look through my Quicken to see if there is anything I'm unconsciously spending too much money on for the value I get out of it. I don't buy lattes though!
I should add I am only looking at these bigger expenses because I have the larger ones under control. My Mortgage is less than 10% of my income monthly and I have a car that I plan to drive for a very very long time.
Lance, that sounds like a great way to have your finances. Periodic sifting through is very useful task, even if you don't find anything. In fact, I will do the same thing 🙂
I agree with the housing, the Honda vs Acura argument, etc, but NOT the private vs public university example you gave. Yes, it saves you money, but in a lot of cases you're also buying into an alumni network. For example, my second job landed in my lap ONLY because of my alumni connections at my alma mater – proving that sometimes, it's not who you know but what you know (and that name "brand" recognition counts).
Alumni networks are beneficial. I think through being active in professional organizations and the leaders in your area, one can build that professional network that will rival what is available at some of the "premiere" schools. Plus, I feel that you would be very surprised at how rich the network is at very high quality public university. For a few things, having a pedigree can matter, but the mass majority of people are over paying for something that they rarely would use.
[…] I am an ‘espresso girl’ and really don’t like Cafe Latte – never mind the time of the day. My feeling about what has come to be known in personal finance circles as ‘the latte factor’ are very similar – I don’t like it and in my experience most of the time having latte is not really the problem. This doesn’t mean that that small expenditure doesn’t matter – quite the reverse; I believe that ‘small’ is an extremely powerful number. However, people should not forget to check their ‘large’ expenditure items – we, for instance, were over-paying on insurance (bad deals, really) and are likely to have ‘too much house’ soon; sometimes you just don’t earn enough. Last week I was very pleased to realise that one of my favourite bloggers, Roshawn, agrees. Yep, often lattes are not your problem! […]
One of the biggest problems is simply not knowing where your money is going. Back in the day, when everything was paid for with cash you had to take special efforts to know where your money went — you had to write it down.
Now it is much simpler (maybe too much so) to keep track. Mint.com does it for you.
Of course, Mint.com can do it because the service (with your permission) accesses your bank/credit/investment info via electronic means, which is also why it is so easy to spend money you should not probably spend — everything is done with a simple swipe of a card.
Way to easy to lose track when you don't even have to pay attention.
Thad,
I completely agree. The tools that we have at our disposal make it easier than ever to track what we are spending on, when we are spending it, and give clues as to why we are spending it (based on temporal relationship between purchases and mood/life events). If we don't know what's going on with our finances, it is typically a deliverable choice not to prioritize knowing what is going on with our finances.
I agree with everything you have said here Roshawn, especially that one-sized financial advice doesn't work for everyone. People who can't save money and afford a Latte have bigger problems than a couple of small money leaks. It's good advice to look at the income and the large expenses first. Why step over dollars to pick up pennies?
Thanks so much Bret. Yeah, one-size fit all advice can be incredibly helpful for the masses, but understanding how it applies (or doesn't apply) to your unique situation is where financial intelligences comes into play.
I love that analogy 🙂
Wow! How the hell do you keep hitting home runs, dude? This is EXACTLY what I saw practicing financial planning: people would try to cut their grocery bill from $250 to $220 per week by buying less fish. Then they lease a car for $800 per month.
Thanks so much Joe!!!!
I love it when people take concepts and provides me with real-life case studies. The example you cite is precisely what I mean. Awesome!!!
There's some truth to the latte argument, but I found the way the argument presented could become offensive. I've seen some people call others dumb for buying lattes, and that it's so stupid to spend their money that way. Perhaps, but a stronger truth is that value is subjective, and a latte may bring a great deal of enjoyment to someone.
You have some great advice here (like usual!), especially regarding the low income. Below a certain point, it's hard to save if much of your budget is going towards the basics. For someone in such a situation, they might want to consider entering a trade or another profession that has decent salaries and doesn't take as much training time or expense as a college/university degree. I'm a university graduate but don't understand why people would look down on the trades. I've done some physical work in my time and have respect for people that do that day in and day out.
I guess any action plan has to be tailored to the person. If someone likes lattes, they need to find the solution that maximizes their own personal life curve. It's possible for someone to be on the wrong track with respect to their own values, even drug addicts would probably prefer to not be addicted. A person's probably more likely to listen to advice that also respects their own values, as well!
I never really thought of it as offensive except for people who are truly broke and doing their best but have no fat to cut. That said, I can easily see how frugal zealots could use the Latte Factor as a weapon. Just like you said, value is absolutely subjective, and the blindly cut something that brings "a great deal of enjoyment to someone" may NOT be the best financial plan long term, provided that they could easily afford it.
You hit the nail on the head: a person is more likely to listen to advice that respects his or her own values; otherwise, they will consider the advice to be generic and from an irrelevant talking head.
Very good argument. Little expenses can take a toll on a budget, but if the big expenses are out of control, that's what one needs to focus on.
That's honestly a big problem with a lot of our finances: we let the big things get out of control in favor of fad-type savings/frugal conventions that have value in themselves but would be best utilizes as a part of an overall expense reduction plan that addressed the biggest threats to their financial goals.
Shawn, I may be a bit extreme, but I believe in spending on what matters most to you (and not everything). That said, we drive old cars and live in a house we can afford and save and invest aggressively!!! Lucky I don't care about having a mansion or a BMW!!!
[…] course not all indulgences are bad for your wallet, as we discussed for the last 2 weeks. You don’t necessarily have to give up your lattes to achieve financial security, and your entire financial plan may be in jeopardy if you deprive yourself entirely. Thus, before […]
[…] the idiocy known as the “latte factor” knows no bounds. Roshawn knocks this silly notion in When Latte’s Are Not Your Problem. Let’s give a well-deserved nod to Jake at iHeartBudgets for doing good work in this same […]
[…] When lattes are NOT your problem – Watson Inc […]
Take care of the pounds and the pennies will take care of themselves!
Individuals once in a while get so overpowered that they have no idea where to begin with contributing for retirement, particularly while attempting to at the same time contribute for a school training for kids,