The first personal finance book I read after graduating college was The Automatic Millionaire by David Bach. It was an eye-opening book and I loved the idea that you could “automatically” become a millionaire by paying yourself first and investing in a diverse portfolio of low-cost index funds. Another concept that was popularized by Bach and his book was the Latte Factor. He recounted a story of how he used to frivolously spend money on a latte everyday and that if he had saved that money instead and invested it, he would have a fortune. Check out the latte factor calculator and see how much money investing small savings can amount to.
Lately, I have seen a lot of criticism of the latte factor. Some argue about Bach’s math and how he calculates the amount you would amass by cutting out the daily latte. “Oh a latte doesn’t cost $5!” “The rate of return he used is too high!” And many argue that they don’t want to cut out their daily latte, that it wouldn’t make much difference, and that they’d be better off focusing on big expenses, not a $5 daily latte expense. One personal finance guru, who I respect, even said that he’d love to “catch” those who tout the latte factor at a Starbucks. I can just picture him seeing Bach or another latte factor supporter at the Starbucks holding a Venti Iced Vanilla Latte and yell, “I caught you red-handed! I knew you’d break down and buy a latte you HYPOCRITE!”
Critics of the Latte Factor seem to be taking the latte factor too literally. Nobody says that you can’t indulge in a latte once in a while. The latte factor is more of a metaphor to demonstrate that if we spend money on little expenses constantly, they add up. On the other hand, if we saved that money and invested it, the magic of compounding over years will give you a nice pile of cash. Many of the critics also argue that we should focus our energies on bigger expenses like housing and transportation, which are a much bigger proportion of our monthly expenses rather than waste time bothering with a $5 indulgence. While I agree that we should make sure that those expenses are reasonable, how often do you really have to spend energy on them. How often do you buy or rent a house? How often do you purchase a new car? Making sure you don’t buy more house than you need or a car that you can’t afford is important but it doesn’t mean you won’t have energy to focus on smaller expenses. You can do both!
The Latte Factor concept is more of a mindset where you are more conscious and intentional with your spending rather than buying latte, going out for lunch, getting a drink after work because, “hey it’s only a couple bucks, it’s okay” mindset. It’s not about deprivation and sacrifice. It’s about conscious and intentional spending. If you change your mindset and try brown bagging your lunch a few times or brewing your own coffee at home rather than buying it outside, you might find that this alternative option works just fine. It doesn’t mean that you are required to ONLY drink home-brewed coffee and that if you step into a Starbucks, you should be called a fraud by a personal finance blogger.
Small savings do really add up, but they won’t if you just leave it in your checking account. Most likely the money in your checking account will start to burn a hole in your pocket and there will be temptation to spend the money you saved by foregoing small expenses. Additionally, that money is not earning much if any interest. You need to invest it So start tracking your expenses and make a budget, which may include money for indulgences like lattes. Find what small indulgences that you can reduce or get rid of and make sure to have the excess money automatically sent to your investment accounts. I recommend using Personal Capital (affiliate link) to help with tracking your expenses and net worth.
Does cutting small expenses really make a difference? What small indulgence have you reduced or eliminated?