If you’ve been doing a bit of reading around the Personal Finance world, you have probably come across the idea of the ‘Latte Factor‘ in one form or another. It’s a shock tactic that works pretty well the first time you see it. “£2.50 on my daily latte adds up to how much!?” you scream skywards the first time you see it’s impact. The next time someone offers asks you to meet up for a latte you go bat shit.
After you calm down you realise the Latte Factor isn’t really a vendetta against the humble latte or even spending on the little things that you enjoy. I try to look at it as a three way lesson in some basic financial principles or lessons.
For anyone saving for the long term, compounding is your best mate. And mortal enemy of the Market Crash.
It’s effects in the long run can be staggering. Every bit of interest (or redeployed dividends or capital gain) you earn immediately starts working hard for you, 24 hours a day, it is relentless.
|Horribly coloured graph showing the effects of compounding|
By considering a small amount invested regularly in the form of a daily latte, we can see the substantial impact that compounding has in the long term.
2. Small regular costs or investments add up
If you are pillock (like I was) you will forego making really easy wins in the world of personal finance.
While you won’t get far just investing in cash that is eaten away by inflation or chucking you gold coins into a treasure chest, you are missing some really easy and significant wins by sorting out these little repetitive expenses.
As the Latte Factor highlights, a small daily or weekly expense can really add up to a significant amount. So you shouldn’t turn you nose up at sorting out your expenses in favour of researching latest leveraged synthetic fund promising to beat the markets. Just because something is an easy win, doesn’t mean it’s wrong or you are stupid for doing it.
You can’t go wrong adding these small amounts to your regular investments.
3. The power of unconscious spending and habits should not be under estimated
The likelihood is that all of these little expenses are flying under your “expense radar”, after all why worry about £3 here or there. It’s only the big purchases that matter, right?
Well my friend, you need to retune your expense radar, as that sucker has gone to shit.
Ever feel that you have your expenses under control but you just never have enough to invest at the end of the month. I’ll bet it’s unconscious habitual spending, and seemingly small amounts at that. You need to start to look at how your brain works and steer it away from constant consumerism. It needs to be redialled, out of the Zombie like state where purchases are just made at whim, so that you become some kind of expense fighting Macgyver, Eventually you will be unconciously not spending and so saving more as a result.
I have calculated some ‘factors’ below.
The first table shows for every daily £1 of expense, how much that would be worth at the end of X years if it was invested instead of spent. Lets call it the Savings Factor.
The cell highlighted in green is for an investment growth of 4% and a daily expense of £1 over 20 years. So for every £1 of daily expenses you give up £11,084 of savings at the end of that period.
It’s not hard then to understand how much £7 a day on tat really adds up (£77,951 with the same assumptions as above).
But we can also look at this from the other side. So the question is now ‘How much additional savings will we need to support these little expenses’ rather than ‘how much could these little expenses add up to if invested?’
Looking at the expenses as daily, weekly or monthly we can generate some new factors. The table below shows the assumed Safe Withdrawal Rate across the top, and the frequency of the expense.
So, for example, the cell highlighted in green shows that for every daily expense of £1 we would need £9,125 of capital to support it, at the every trust worthy 4%. The amount of capital increases as we reduce the withdrawal rate, as you’d expect. Lets call it our Expense Factor.
Random thought 1
Playing around with the numbers, keeping the growth rate and Withdrawal Rate at 4%, we can make the Savings Factor = Expense Factor when the number of years of saving is about 17.42. I.e. after 17.42 years of saving a daily £1 the savings balance starts to provide us with with enough capital to withdraw £1 a day.
Of course this number would change with the growth rate and withdrawal rate.
But this goes to show how easy it is to spend money and just how much effort it takes to save a substantial nugget.
Random thought 2
With the growth rate the same as the withdrawal rate at 4% and over 20 years, we can see that;
It seems that a penny saved really is a penny earned.
Random thought 3
So, at our friendly 4%, your daily latte at £2.50 a pop could be reducing your savings pot by £27,711 over the next 20 years and then cheekily demanding £22,813 in capital to support the daily habit. That latte guy makes me so angry.
The moral? Forego the latte now and invest the money for 20 years. Then use that to have a daily latte for the rest of your days (assuming your withdrawal rate isn’t too aggressive), you’ve earned it.
Spend Less, Save More & Escape the Horde
PS – IT’S FINE TO DRINK A COFFEE