When you're trying to get ahead financially it can be easy to look at only the large expenses in your budget, and focus your attentions on finding ways to cut those.
Some have said, however, that keeping your focus only on the big things is a big mistake. In order to get ahead you should focus on the whole financial picture – the big and the small expenditures in your budget.
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The Latte Factor®
In his book The Automatic Millionaire author David Bach coins the term “The Latte Factor®” to focus on how if you want to “finish rich” in retirement you can simply redirect spending on small discretionary budget items (things like your daily latte, bottled water or cigarettes) towards spending on yourself. Cut back on discretionary items, and spend that money instead on savings for retirement.
Here's how he explains it on his site:
The Latte Factor® is based on the simple idea that all you need to do to finish rich is to look at the small things you spend your money on every day and see whether you could redirect that spending to yourself. Putting aside as little as a few dollars a day for your future rather than spending it on little purchases such as lattes, bottled water, fast food, cigarettes, magazines and so on, can really make a difference between accumulating wealth and living paycheck to paycheck. We don't even realize how much we're actually spending on these little purchases. If we did think about it and change our habits just a little, we could actually change our destiny.
So if you want to finish rich Bach suggests that you should:
- Identify small things you spend money on every day, or regularly.
- Figure out if you could redirect that spending to a savings goal, and then do it.
- Over time those small savings amounts add up.
Changing your habits even just a little bit over time can mean big changes in your financial future. Here's a discussion we had surrounding The Latte Factor® on a recent Money Mastermind Show.
Small Savings Amounts Add Up Quick
On his site David Bach has a “The Latte Factor® Calculator” that helps to illustrate just how much those small savings amounts can add up to over time. For example, if i were to redirect a regular daily $5 coffee habit to savings (more like $5.50 in my area for specialty drinks), over time those small dollar amounts would add up. Here's the breakdown of how $5 daily, weekly and monthly coffees redirected to savings will grow over time at a conservative 6% rate of interest. At a return of 6%, those daily small $5 savings amounts add up to $299,387.02 over 40 years. If you only nix one $5 weekly coffee for a contribution, even that will lead to $42,652.40 over 40 years. Still a significant amount of money.
Your Latte Factor May Be An “Eating Out Factor” (Or Something Else)
While the name “The Latte Factor®” is catchy, I think for many their “factor” that causes them to overspend may not necessarily be a morning coffee. Their money leaks may be in another area. I know for years our family has had an “eating out factor”. We would spend $5-10 to eat out just about every day of the week. If instead we had been making our lunches and bringing them to work, I shudder to think how much money we could have saved. The key is to sit down and figure out where your weak areas are. Some of the more common areas for money leaks to arise:
- Eating out: Eating out every day can add up quickly, $5-10/day can add up to $300/month or more! Over 30 years that could mean in excess of $300,000 at 6% interest! This has been one of our problem areas.
- Coffee and/or snacks: Having a daily coffee, energy drink or donut can easily cost you $5-7/day. That can add up over time!
- Books, magazines, music downloads: While most people probably don't buy books or magazines daily, even buying a few in a month can add up to the equivalent of a few dollars a day.
- Unused services: Often we're paying for a higher level of service than we need, or we're paying for features that we're not using. Find those extra features, products or services that you don't need, and cancel them! That can add up to quite a bit of extra cash to invest!
- Online spending: For many, with the advent of the internet, shopping and making impulse purchases has become easier than ever. Take the time to look at just how much you're spending on Amazon or other online retailers, and you might be surprised.
Cons To The Latte Factor®
The Latte Factor® has it's detractors and critics. There are a few main reasons why:
- Too much focus on the small expenditures: Some people say that the amount spent on a coffee here and there really doesn't add up to as much as some might say. They say it encourages people to focus on small expenses, when they should be focusing on the big wins. I do think this criticism is one of the most valid – that if you focus too much on smaller things it can be a problem. You do need to focus on the big and small things I think to have a successful outcome.
- The numbers: Other critics say that Bach gives unrealistic expectations of how much interest you can earn on your savings. I think he may have given numbers in the 10-11% annual returns range at one point, which some people point to, but as Bach says about The Latte Factor®, “It's a teaching method to get people to “re-think” how they spend money, and realize they have more than enough to start saving. It's not about guaranteed returns, and my books don't promise 10 percent returns. And my books show in many cases compounded interest rate examples from 1 percent to 10 percent.” To be honest, much of the criticism in this area feels like nit-picking to me. The idea is that we all have extra money that we could be saving. It's about changing habits and making honest choices in how we spend or save.
- You need to splurge every once in a while: Another criticism of The Latte Factor® is that it encourages burnout – due to the fact that it never allows people to splurge or enjoy life's little luxuries. Why not have a coffee if you want one? I don't think anyone, David Bach included, would ever say that people should give up their coffee (or other spending) completely. It's about making a conscious decision to say that maybe it isn't necessary every day, and that I could plan ahead for my future by cutting back in some ways.
Saving Your Money In Small Amounts
To me the power of The Latte Factor® is to point out that even small amounts can add up to large amounts if you give it enough time. Make a sacrifice here and there, and save and invest for the long haul, and in the end you'll come out much further ahead in the end. My Experiment In Regularly Saving & Investing Small Amounts I recently started an experiment on this site in order to see just how much I could save if I used automatic savings and investments in small amounts – without even thinking about it. To do this experiment I signed up for two services, a savings account and an investing account:
Digit.co has an interesting business model where they save money for you on a regular basis without your intervention. It analyzes your checking account balance and regular spending, and when it thinks it won't overdraw your account, it will save money to your Digit savings account in small amounts – anywhere from a few dollars to $30-40 or more. Over time those small savings amounts add up to larger amounts – and in the end you probably won't even notice the money has been taken out. Once the balance in my Digit savings account reaches $75 or so, I take the money and move it to my Roth IRA at the free investing service WiseBanyan. So far in the two months that I've been doing the experiment I've saved and invested almost $630 via Digit and WiseBanyan. Over an entire year that works out to $3780, which is over half way towards fully funding the Roth IRA for the year. I never even missed the money since it kind of trickled out of my account – instead of going in one big chunk!
The Power Of Making Small Cuts & Saving For The Future
The power behind the idea of The Latte Factor® is the idea of being intentional about your spending and saving decisions, and realizing that even the small choices you make every day have an effect. What is the opportunity cost of having that cup of coffee? If you choose to forgo your coffee a few days a week and instead save that money, how much more will you have saved when it comes time to retire? Don't forget that focusing on small things like a cup of coffee is only just the start, and that focusing on the big things in your financial life is just as important. Having one bad home loan or unpaid credit card can effectively wipe out any gains you might have made through your savings on the small things. Stay on top of your whole financial picture! As for me, I'll likely still be having that coffee at Starbucks every now and again, I'm not one to completely forgo any of life's pleasures. Having something less often means you'll look forward to it more anyway, right? Have you ever tried implementing the ideas behind The Latte Factor®? Did you find you were able to successfully cut back in some areas in order to save more?