One of the most common phrases in the world of personal finance is one coined several years ago by David Bach – The Latte Factor. If you’ve read one of Bach’s books or seen one of his presentations (fairly likely, they’re very popular), then you’ve no doubt heard about it. If not, you can check out his website here.
The premise is simple: The little things that you buy on a daily or weekly basis add up to a huge amount of money in the long run. Hence the reason it’s called the Latte Factor, the money you spend everyday getting that fancy caffeine from Starbucks or wherever else can add up to a small fortune in the long run. But this theory goes far beyond just coffee, it extends to anything small you frivolously spend money on, like cigarettes, magazines, snacks, banking fees, or thousands of other possibilities.
This is a brilliant no-brainer in my opinion. The fact is that these purchases look small when you buy them at the store everyday, but even if you look at it from a monthly basis, they add up very quickly. So I decided to run some math with a few common types of “Lattes”, and hopefully I can illustrate just how true Bach’s ideas are.
The Latte Addict
Of course I have to start with a latte, not only for the sake of the name, but also for the fact that they are one of the best examples. In modern American society, getting a cup of Joe from a Starbucks every morning is a very common routine. Lets say that Person A is spending $4 including tax every weekday getting some fancy coffee drink that isn’t even half coffee before work. Assuming working 5 days a week 50 weeks a year, for a total of 200 work days, that means Person A is spending $800 per year on coffee. That little cocktail of chemical “energy” and artificial colors/flavors may seem like a tiny expense every morning, but, at least to me, $800 a year is no small amount of money. If person A is making a fairly typical yearly salary of $40,000 before taxes, that means that coffee is responsible for 2% of that person’s pay even before taxes are taken out. Another way to look at that is that they have to work an extra four days per year to pay for the coffee.
Now if Person A, instead of spending that $800 on lattes, invested it in the stock market every year and got an average return of 7%, that would become almost $12,000 in just ten years, the cost of a very nice used car. How about in 40 years? $170,000. That’s right, for the price of getting coffee on weekdays, Person A is giving up enough money to buy a decent house in most cities.
The Celebrity Addict
Now, lets take a look at Person B. Person B just can’t get enough celebrity gossip. In fact, they constantly buy magazines just to keep up with which fake person they think they know but have never actually met is getting divorced and whose fault it is. This rings up at a total cost of $10 a week. $10 a week? That’s nothing! Person B is making $50,000 a year, why on earth would they care about $10 a week? Well if we run some of the same math as above, we realize that Person B is spending $520 per year on magazines that they throw out soon after purchasing anyway. After 40 years, that’s just over $111,000. In other words, those worthless bits of gossip are costing Person B two years salary during his career. I for one would much rather have two more years of retirement than know which celebrity couples accidentally impregnated each other. And if they really need that gossip that bad, they can find it online for free.
The Crappy Fast Food Addict
Another extremely common example for the average American lifestyle is someone who eats out at least once per day. Person C, as we’ll call them, eats out everyday at work, and at least once a day on the weekend. Person C eats at fast food chains occasionally, but mostly sit down restaurants because they can “afford it”. Person C spends an average of $8 more on a meal than if it was cooked at home. They justify it seeing as their corporate life doesn’t allow time to do such crazy things as cook a decent meal, and they’re making big bucks anyway, as in $100,000 a year. Now its true, that is a big salary, but how much of that salary is going straight to eating out? At $8 a day, that adds up to $2920 a year. Yeah, Person C is spending almost three grand per year on eating out! And he’s only doing it once per day, imagine if he was doing it two or three!
If you add in the same compound returns as above, after a decade, eating out has cost Person C $43,168. Enough money to take several extremely lavish and overly expensive vacations. And at the end of poor Person C’s career, 40 long years of working and eating at expensive restaurants, Person C could have had $623,739.94. Yeah, well over half a million dollars, and six times their salary. Sure it was convenient at the time for them, but I personally would rather take six years more retirement and eat healthier food instead.
Finding Your Latte Factor
You can see why the Latte Factor is something worth eliminating from your life. Hundreds of thousands of dollars are literally at stake. But how do you go about finding such expenses in your life? Not everyone drinks expensive lattes, but most people do have some sort of frivolous, repeated expense that has the same characteristics. To find yours, track the various things you are spending your money on everyday. Keep your receipts if you need to. Look for any kind of unnecessary expense that is repeated consistently. There are literally thousands of possibilities, the above examples are just a few. The key is to look for things that you buy consistently but don’t necessarily need, or could maybe substitute in something else that is far cheaper.
Calculating Your Latte Factor
Once you’ve found out what your latte factor is, you can then calculate what exactly it is costing you each year, and how much you can save up in the long run by eliminating it. There are several ways to do this. You can try using David Bach’s calculator here, but it only allows you to do certain, specific scenarios. If you want to do it the way I did it, simply figure out your yearly expense total on that item (cost multiplied by number of purchases per year), and then put that number into a compound interest calculator online with your average investment return. A quick Google search of “compound interest calculator” will find you several that should work well.
Factors, not Factor
The scariest thing about the Latte Factor is that in most cases, it isn’t a factor singular, but factors plural. Most people who do have substantial latte factors in one area are much more likely to make other frivolous purchases. For instance, Person A in the above example who buys lattes daily is also likely to be like Person C and eat out a lot. Can you imagine the amount of money people spend if they have multiple bad habits? Just think about someone who smokes a pack of cigarettes every day, eats out twice a day, gets a latte in the morning, and drinks twice a week at a bar. I figure that between all those things, they are spending about $200 per week, if not much more. At that rate per week, they are spending over ten grand per year on just those four things. And after 40 years? Make sure you aren’t holding anything spillable when you look at this number. $2,221,539.53!! Now think, they could be paying for expensive cabs to get home from those bars, getting two lattes in the morning to wash off the hangovers, and who knows what else. My point is this: people with one latte factor will often have many more than one, so if you have one that you know about, think about what else you’re spending your money on.
When all is said and done, it’s clear that the Latte Factor is a very real thing, and I think it can be a major reason why people aren’t living their dream financial life yet. Even the smallest factors can add up to be hundreds of thousands of dollars, and that kind of money can easily help you retire early, work less, invest in something you really love, or help those in need. If you have a latte factor (or even a bunch of them), it isn’t the end of the world. The best part about the latte factor is that it is the easiest kind of expense to eliminate. Find your latte factor. Tackle it with pride. Love life. (<— Click to Tweet That)