The Latte Factor (From the Automatic Millionaire by David Bach)

Link to David Bach’s website: http://adjix.com/djq3

 

What is the Latte Factor?  The Latte Factor is the small daily routine expense people make that determine whether they would retire rich or live paycheck to paycheck. 

 

I have learned a simpler lesson about the Latte Factor from my brother (to my surprise).  What he did was he save $10 a day from his Valet Parking gig for a month.  At month’s end, he had $300 to buy his Mini DV Camera.  Although the result was a purchase of a now obsolete liability, the lesson still sticks. 

 

People these days complain that they have nothing left from their paychecks to save money for retirement or even for an emergency fund.  Although there are countless ways to save money for savings, an easy way to do this is identifying your Latte Factor.  People think that they need to cut big ticket spending like not going on vacation for 5 years and the like to save money but actually, all they need to do is do a spending journal.

 

Taking the example David Bach gave on the Automatic Millionaire, he interviewed a woman about her daily expenses (She complained that she could not save money).  She disclosed her daily routine going to work was to buy a tall Latte ($3.50) and a muffin (Non-Fat $1.50).  Then for a snack, a fruit juice ($2.50 plus a $0.50 boost shot) and a Granola Bar ($2.00).  By then David stopped the exercise and pointed out that she already spent $10 before lunch and she never really had anything to eat.  As humorous as it sounds, most people live their days with this kind of routine hence, the term: Latte Factor was born.

 

So just by using the Latte and Muffin numbers, we can run the following numbers:

 

$5 a day x 7 days = $35 a week

$35 a week x 4 weeks = $140 a month

$140 a month x 12 months = $1,680 a year

 

With those numbers, a person who skips this Latte Factor everyday would have had $1,680 a year.  That is a month’s rental/ mortgage payment!  In addition, when you invest that money that gives at least 4% returns (I choose 4% to be conservative and assume the money would adjust for inflation) we can run the following numbers:

 

Initial Investment: $140                         Monthly Investment: $140

 

Year 1 = $1,747          Year 10 = $20,977      Year 35 = $128,685

Year 2 = $3,564          Year 15 = $34,985      Year 40 = $166,028

Year 3 = $5,454          Year 20 = $52,028      Year 45 = $211,462

Year 4 = $7,419          Year 25 = $72,763

Year 5 = $9,463          Year 30 = $97,991      *Calculations made on Finish Rich Latte Factor Calculator

 

At first look, I could not believe the numbers. How can a simple daily $5 purchase amount to that much?  The answer is the power of compounding.  From the number above, if a 20 year old got rid of his Latte Factor, by the time he reaches 65, he would have $211,462.  Can you imagine a $5 latte a day would cost you $211,462?  I do now.

 

It seems too easy or too good to be true.  I know, but going back to my brother’s example, a simple reduction of our personal Latte Factor can save us money.  Even if you kept the money under a mattress, $140 a month for 45 years would have been $75,600.

 

Let me use another example:

 

A friend of mine smokes 2 packs of cigarettes a day, drinks two lattes a day, and goes out for happy hour (drinks two bottles of Beer)

 

Latte Factor:

Cost of Cigarettes: X Lights $15.89 per carton (10 packs per carton = $1.59 a pack) *taken from online cigarette store

Cost of Latte: Tall Latte $3.00

Cost of Beer: X Beer $15.49 per case (18 Bottles per case = $0.86 a bottle) *taken from BevMo website

 

Cost per day:

Cigarettes = $3.18                    $10.90 x 7 days         =  $76.30 a week

Latte =         $6.00                   $76.30 x 4 weeks      =  $305.20 a month       

Beer  =         $1.72                   $305.20 x 12 months = $3,662.40 a year

Total =         $10.90                 $3,662.40 a year with 4% yield for 40 years = $361,942.31

 

Makes you want to quite smoking and drinking huh?  A couple of weeks ago, the same friend of mine complained about not being able to save money.  He recently took a pay cut of 10 % to avoid a mandatory furlough that would have cost him 20% of his pay.  I asked him why he could not save and he has no clue.  Meanwhile, I know about his smoking habit.  The happy hour trips after work.  The Latte runs and I am not even mentioning the shopping and eating out. 

 

If only my friend can identify his Latte Factors, he could have had a decent amount of money in savings.

 

The lessons learned from the Latte Factor are very important.  It teaches us how small expenses add up to huge losses.  It also gives us a glimpse of how the power of compounding can make a simple $5 savings into a huge nest egg.  Although simply identifying your Latte Factors may not make you rich tomorrow (short of winning the lottery), it is a simple but important first step towards a wealthy retirement and that is a worthy goal for everyone to achieve.