The marketing department at Chase might be good at getting people to sign up for credit cards and home mortgages. However, they’re not all that good at explaining “the latte factor.”
In a recent Tweet, Chase suggested that many people are unable to make ends meet because they fail to make coffee at home and cut back on other minor, unnecessary expenses.
Due to public outrage, Chase deleted the Tweet and apologized (including a counter-tweet from Sen. Elizabeth Warren). While Chase’s intentions were rooted in explaining the age-old “latte factor”, their oversimplification didn’t do it much justice. So, we’re here to walk you through what it really means.
The Latte Factor
The Latte Factor is the concept that small purchases add up over time and cost people a comfortable nest egg at retirement. David Bach was the first to coin this term. Bach is a famous author who has written popular books like “The Automatic Millionaire” and “Finish Rich.”
In “The Automatic Millionaire,” Bach relates the story of a young woman who claimed she could save nothing for the future. He then asked her what her day consisted of.
Her first move every workday was to buy a latte. Then, she’d buy breakfasts and snacks on most days. Before lunch, she would frequently plunk down $10 or more.
By cutting out the daily latte and noting the power of compound interest over time, Bach showed this woman that she could have a very substantial nest egg by the time she would normally be ready to retire.
It’s a bit of a stretch to say that Bach would encourage readers to avoid all Starbucks for the rest of their lives. However, the latte factor shows that we frequently make repeated small purchases mindlessly.
These add up over time, and they can be the very thing that could cut our retirement lifestyle from one that’s quite comfortable to one in which rice and beans become our daily fare.
Bach’s argument is not without critics. Some people complain that Bach’s $5 cost for a cup of coffee is inaccurate. They also question his assertion that investors could get a 10% to 11% return on their money.
Let’s Do the Math
David Bach has a Latte Factor calculator. By assuming a mindless daily spending rate of $10 with a 6 percent annual return, the numbers are staggering.
Even at this very modest estimated return, $10 wasted each day on lattes, cigarettes, lottery tickets or all of the above would compound to a nest egg of nearly $600,000 in savings over a 40-year period.
Even cutting out this level of spending for 10 years would build up to a stash of $50,000. With a higher average return, the cost of mindless spending could easily reach the $1 million mark.
What If I Don’t Drink Coffee?
You’re not off the hook if you don’t drink coffee. There are small purchases other than coffee that can add up to a large wealth tax. Purchasing a bottle of water each day could cost about $2 if purchased at the wrong place. A pack of cigarettes could run $8 to $10 daily.
One of the more common unnecessary expenses for Americans is eating out. The average American spends $232 a month eating out. Cutting this number in half could lead to a nice nest egg over the course of a few decades.
By plugging the leaks in your budget, or at least slowing them down substantially, it’s possible to build wealth over time. So, skip the Starbucks next time and begin putting that $5 into your safe or money jar instead. You just might be surprised by the results.