Don't Stop at the Latte Factor

Why math is so essential to healthy financial habits.


Schools throughout the country are beginning to introduce money management lessons into mathematics classes. For a young public that is confused about compound interest, doesn't know how to balance a check book, and wonders how their lives become consumed by debt, more attention on personal finance during adolescence can only be a positive influence.

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Math classes are probably the most relevant subjects for incorporating personal finance, but it takes more than skill with numbers to be able to build wealth over time. Managing your own or your family's income and expenses requires understanding of the psychological side of money, as well. If it didn't, the popular mantra of "spending less than you earn," a mathematical concept usually understood by fourth grade, would be all that's needed to thrive financially, and consumer debt would be nonexistent.

That's not the case. Those who have unmanageable debt understand how negative numbers work, so mathematical knowledge is not the problem. There is a psychological problem to be addressed. This is one reason David Bach's concept of the Latte Factor is popular and effective. Here's how it works:

Change a habit, such as an unnecessary daily morning drink, and replace it with a less expensive option like brewing your own coffee. Repeat the process every day until the new behavior becomes a habit. The new, more frugal behavior becomes normal, and as a result you'll save $15,000 over the next twenty years, assuming your savings is $3 a day, five days a week, for 50 weeks a year. That's not a bad addition to your retirement fund. If a reader takes anything away from David Bach's The Automatic Millionaire, the Latte Factor is it.

Don't drink expensive coffee-related drinks? Replace "latte" with any unnecessary habit you pay for. Really love your lattes and feel they necessary for functioning? Keep them if you can afford it and find another opportunity to change a habit. What most would-be savers don't realize, however, is the repetitive, small savings are not enough, even if they add up over time. With one swift signature, you can easily wipe out your latte savings.

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

Here are some of those mistakes.

1. Buying a new vehicle instead of a cheaper but reliable used car. While buying a used car isn't always the best solution to a car problem, in most cases, you will save more money in one decision that you can make up for with years of latte reductions. Buying a late model used car and letting someone else pay for the loss of value in the first year or two of ownership must go hand-in-hand with repetitive savings. Leasing a car and cycling through new vehicles every few years also contribute to lower wealth over time. Cars are a major expense that can quickly undo any savings from daily lattes.

2. Having less than stellar credit. When you go to buy a house and qualify for a mortgage, just a few blemishes on your credit report and a lower credit score will result in qualifying for a higher mortgage rate that you would have otherwise. Even a rate one percentage point higher could result in owing $55,000 more in total interest payments on a $250,000 loan over 30 years. That's a lot of lattes.

3. Not banking your latte savings. It's great to say you've changed your latte habit, but if you aren't saving that money in a high-yield savings account or investing it for retirement, you've simply shifted your spending from one frivolous expense to another and you won't see any financial benefit.

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Taking the fun out of life isn't the goal of personal money management. Financial choices are personal and unique to each individual or family. The basis of making better decisions about your money is weighing your needs against your wants, and allowing some of the wants when possible. Eliminating the latte or other unnecessary repetitive expense is just once small piece of the process. Don't fall for the false security you may feel after eliminating a daily latte. The job isn't done unless you consider every spending decision, especially the large expenses, as carefully as possible.

Luke Landes writes for Consumerism Commentary, where he encourages discussions about money and consumer issues. Consumerism Commentary regularly tracks and reviews the best online savings accounts and other financial products.