Every day it becomes increasingly clear that the Great Recession marks the beginning of a a New World Economic Order. And with the new comes an end of many parts of the old. Some will not be missed. (E.g. no-doc mortgages, investment banks, Circuit City.) Others will be missed by the nostalgically inclined. (Newspapers that actually print on paper, the Big Three Automakers, movie theatres.)
And last week Free Money Finance brought sad news of another part of our culture that is disappearing. Maybe The Latte Factor is Now Less of a Factor? Apparently, caffeine vendors from Starbuck to McDonald’s are now cutting prices, meaning that doing without your morning fix just isn’t the compelling savings it once was.
Not that it was really ever that compelling. Indeed, I am saddened by the news because The Latte Factor® is such an excellent example of symbolic frugality that I will miss it. Realizing that this may be my last chance to take it out for a spin, here goes.
The Latte Factor® was originated by David Bach, author of The Automatic Millionaire. (He only uses the R in the circle thing the first time he mentions it. I will use it every time because I’m proud I got my editor to do it and because I think it’s funny.) The Automatic Millionaire is itself something of an outdated antique, published long ago when how to become rich, rather than how to avoid being poor, was the usual focus of personal finance books.
In a nutshell, Bach’s point was that although you feel that you have no money that you could save, you spend $3.50 a day treating yourself to a latte at Starbucks. If only you did without this frivolity you could save this money and become rich.
Bach makes his case for The Latte Factor® using some very dubious math. Recounting his conversation with a young lady with a caffeine habit, he starts by deftly grossing up the $3.50 latte into $5 a day with the non-fat muffin included. Then he annualizes saying “That equals $150 a month or almost $2,000 a year.” I am the kind of guy who intuitively knows that $5 a day is $1825 a year and guys like us do not think that that is almost $2,000. He continues “Figuring, say, a 10 percent annual return, which is what the stock market has averaged over the past fifty years, how much do you think you could save by the time you are sixty five?” Bach then triumphantly informs the twenty-three year old that those lattes were costing her nearly $1.2 million retirement dollars.
Bach is right that the US stock market has averaged about 10% over the past 50 years. But inflation was also relatively high during the second half of the Twentieth Century, so the real, inflation adjusted, return was meaningfully lower. Even if we assume that the experiences of the previous decades will be repeated over the next ones, that $1.2 million Bach promises the latte drinker will not be worth what she expects when she retires. In fact, assuming an inflation rate of 4%, it will take $5.19 to buy in 42 years what $1.00 buys today. So $1.2 million when she is 65 is the equivalent of only about $231,000 in today’s money.
And then there is the recurring wet blanket known as taxes. Lop off a fourth as a rough estimate, assuming the use of a tax advantaged retirement account [is not used]. So that gets me to an inflation-adjusted, after-tax, latte-based retirement nest egg of around $173,000.
Which is still not bad. But keep in mind that it comes at the cost of a latte and muffin a day, seven days a week, for 43 years, or a grand total 15,695 forgone Starbucks visits. It’s entirely possible that those untaken coffee breaks would have been enjoyable.
The Latte Factor® is an example of what I call The Popeye Ploy™. (I use TM on the advice of my attorney, who says that it is more amusing.) The Popeye Ploy™ is a strategy for getting someone to do something that they do not want to do even though it is good for them. Imagine that you want your kids to eat more spinach, which will over time have positive health benefits. Unfortunately, your kids are not very appreciative of the long term effects of a healthy diet on such things as blood pressure and cholesterol. So you take some liberties with the truth. Eating spinach, you tell them, will within seconds give them an immediate boost in size and strength that will allow them to beat up any bully.
So it is with The Latte Factor®. Saving money by not absent-mindedly spending so much on expensive frivolities is a good thing. But it is not that good a thing. It is not particularly exciting and the payoff after many years is relatively mundane. $173,000 may be, probably is, preferable to a lifetime of lattes. But it is not a slam dunk and Bach worries that if the numbers are not really compelling, you, his child-like listener, will not bother.
The idea that you can become rich by passing up on some of your many incidental purchases appears to strike a chord with many. This is not because the numbers are all that compelling. It is because the psychology is. I believe that the most effective place for most people to economize is on the things on which they spend the most. The practical problem with that is that those big-ticket purchases are relatively rare, so saving money on them gives a person too few opportunities to feel virtuous. Worse, it takes some planning and waiting, while not going to Starbucks is something you can do today.
[Photo: Tim Boyd]