Alpha Consumer

September 2, 2010
• Comment (16)

The Latte Factor, a term coined (and trademarked) by personal finance guru David Bach, is one of the most talked about concepts in the world of personal finance. But it might be based on faulty math.

[In Pictures: 8 Painless Ways to Save Money.]

Bach argues that people waste so much money on little everyday expenditures, such as coffee, that it ends up costing them hundreds of thousands of dollars over the course of their lifetime. According to his calculations in his book Start Late, Finish Rich, buying a latte, or the equivalent splurge, ends up costing people \$2.7 million dollars.

Here’s how he gets to that shockingly high figure: His so-called “Latte Factor” includes all kinds of expenses, such as manicures, massages, restaurant meals, and premium cable. In the example he uses, the total cost of these extra expenses comes to \$1,100 a month. Over 30 years, he says, that money is worth almost \$2.7 million. That’s true – if you can somehow find an annual interest rate of 10 percent. As anyone who has invested money over the last decade knows, 10 percent returns are pure fantasy.

Here are five reasons why Bach’s argument doesn’t add up:

1) The Numbers. Here’s a more realistic look at the cost of buying one latte per day: If you spend \$3 a day on coffee and if you could otherwise earn a 3 percent return on your money, then you could have just over \$50,000 after 30 years. That’s not chump change – in 30 years, it might pay for half of a year of college – but it’s also not going to make you a millionaire. You can run the numbers yourself on Bach’s website using his “Latte Factor calculator.

[For more money-saving tips, visit the U.S. News's Alpha Consumer blog.]

2) The Splurges. Contrary to Bach’s suggestion, people don’t always treat lattes as gateway purchases towards scones, bagels, and other bakery items. That’s one way he inflates his Latte Factor – by assuming that when you buy a \$3 coffee, you actually end up spending much more than that on other food items, too. In his example mentioned above, he even includes spa treatments. So to be accurate, his Latte Factor should actually be called the “Everything But the Kitchen Sink” Factor. But that doesn’t quite have the same ring to it.

3) The Tradeoffs. We make decisions about what to spend money on, and what not to spend money on, everyday. Some of us prefer to put cash into our pets but skip restaurants; others prioritize shoes over electronic gadgets or vice versa. For some people, buying fancy coffee is a priority because it brings them pleasure. They might save elsewhere, by bringing a bagged lunch or skipping a few cocktails later in the day. People are smart enough to make these trade-offs based on their personal preferences. It makes no sense to randomly demonize lattes as an erroneous purchase for everyone.

4) The People. When people buy lattes, they are forced to talk with people – the barista, a cashier, and possibly even other people in line. For people who work at their desk all day, this might be the only time they leave the office, or engage in idle chatter. Since research shows that spending money on things that increase the amount of time we spend with others makes us happier than purchases that are purely material, buying a latte might make perfect economic sense.

[Visit the U.S. News Personal Finance site for more insight and money management tips.]

5) The Caffeine. A latte is not just about taste. It’s about the caffeine. Drinking coffee can make us more productive, better able to concentrate, and even improve our overall mood. It might even help you earn more money, if the coffee means you finish a project more quickly or meet your deadline under pressure. With those benefits, how can anyone argue that \$3 on a latte is misspent?

The bottom line: Go buy a latte, guilt-free.

Kimberly Palmer is the author of Generation Earn: The Young Professional’s Guide to Spending, Investing, and Giving Back, which will be published in October by Ten Speed Press.

Tags:
personal finance

http://www.clixsense.com/?3257286

How you people turn everything into a political argument blows me away - they are talking about lattes, not politics. Why don't all you liberals and conservatives, tea partiers and commies go have a latte and take a chill pill then go put your comments on a site that is actually related to politics?

By minimizing avoidable daily expenses I have amassed a lot of savings. Much more than \$50000 in less than 10 years.

Alpha Consumer

Kimberly Palmer, senior editor for U.S. News & World Report, writes about making smarter financial decisions. She’s the author of The Economy of You: Discover Your Inner Entrepreneur and Recession-Proof Your Life and Generation Earn: The Young Professional's Guide to Spending, Investing, and Giving Back.