We all know that we should be saving more. With rising healthcare costs, increased costs of living, higher taxes, etc., retirement is becoming a very, very expensive proposition. And even those investors with well-laid plans could still use some help to make sure they hit their golden years running.
One of the common pieces of advice on how to go about saving those extra-needed dollars continues to be one of the silliest and most misunderstood axioms in all of personal finance.
I’m talking about the ‘latte factor.’
The idea that your morning cup of coffee is what costs you serious dollars has been paraded around financial media for decades now as truth. But there is really more to compounding and your priorities than your daily caffeine addiction.
Et Toi, Vanguard?
Coined by personal finance guru David Bach, the latte factor has taken on a life of its own in the subsequent years since the release of his book “The Wealthy Barber.” The basic tenant of the concept is that your daily habit of spending $5 on a Venti coffee from Starbucks (SBUX) is what’s keeping you in the poorhouse. Bach argues that if we were to save the amount of money spent on lattes and compound it over 20 or 30 years, we’d help cover the shortfall in our retirement savings.
These small, daily luxuries add up – and we are spending too much on them.
Mutual fund and investing powerhouse Vanguard recently weighed in on the issue with a new blog post geared toward financial advisors. The overall theme was designed to help advisors get their clients to save more. In it, they provide the math on the latte factor and how that small amount adds up over time.
Vanguard estimates that a premium cup of coffee costs around $3.50 per day, or about $1,260 per year. Saving that amount for 30 years in an IRA would net you $106,000. That’s assuming a 6% annual return. That’s a pretty decent amount of savings from simply eliminating your morning cup of coffee.
Just Drink Your Darn Coffee
The problem is, your coffee isn’t what is preventing you from saving nor is it your gym membership. Or even the number of times you get a haircut, as Warren Buffett once said. Small ticket items do add up, but it’s the larger issues that are the albatrosses around your neck.
Paying too much for life insurance, owning too much space for your needs, driving new/luxury cars, etc., are all what’s keeping us down. For example, roughly 18% of Americans pay more than $2,500 per month for their mortgages. Do you need a five-bedroom McMansion when the average family size in America is 2.76 people? Probably not. And when you add in all the costs to heat/cool and keep that house running, you’re probably looking at a lot more than the $3.50 per day for your coffee.
And don’t even get me started on the sheer amount of credit card debt that has cost us 8% to 36% in interest.
It’s the spending too much to keep the “American Dream” going and the keeping up with the Jones’ attitude that are what’s preventing us from saving enough for retirement. It’s not your daily dose of caffeine.
Moreover, there have been plenty of psychological studies recently exploring the idea of purposeful spending and how small luxuries can bring a person more joy than larger ticket items. I can almost guarantee you that no one is happy paying double-digit interest every month on their credit cards.
The Real Advice
If we look at the latte factor from a different lens, it might prove to be useful. Maybe the idea isn’t to “save your coffee funds,” but more as a tool to analyze our individual spending habits to figure out our priorities. We all have holes we can fill and things we could eliminate to save more. That’s the real key.
Starting with our big ticket items – housing debt, insurance, etc. – first is what will truly net us real savings. It’s here that most Americans overspend, not at your weekly golf game or daily doughnut.
In the end, the latte factor is flawed in that it’s causing us to focus on the wrong thing when it comes to spending/saving. Focus on where it counts and then save the difference. Your portfolio will thank you.