It’s a rule so basic that it’s been touted in just about every personal finance book and blog post on savings in the last decade.Want to save more? Try ditching that daily coffee habit.
Among those who championed the idea that Americans’ love for little luxuries was the culprit behind their inability to save was personal finance guru David Bach.
He coined the term “The Latte Factor,” even adding a calculator on his website to show people how much their caffeine kick cost them.
According to Bach’s maths, a woman in her early 20s could tuck away $2,000 a year by saving the $5 she might spend per day on a latte and snack at Starbucks. Invested with an expected return of 10 to 11 per cent, that savings could grow to more than $1 million by the time she hit retirement.
“There was only one thing wrong with the latte factor,” writes Helaine Olen in her forthcoming book, “Pound Foolish: Exposing the Dark Side of the Personal Finance Industry“: “It wasn’t true.”
By her calculations, the maths didn’t add up.
“It didn’t work in terms of what we were actually spending our money on,” she writes. “And it didn’t take into account what life costs were actually rising or falling. The latte factor was, to mix our drinking metaphors for a moment, the financial equivalent of the Miller beer –– it tasted great, but was less filling.”
Here’s her reasoning:
$5 a day? Not quite. First off, you’d be hard-pressed to find a latte that sells for more than $5 a pop. Bach factored a chocolate biscotti and other incidental snacks into his total. “Even then, his numbers didn’t quite add up,” Olen writes. “Five dollars a day, 365 days a year, is $1,825. So Bach ’rounded’ the number up to $2,000 annually, the better to exaggerate the amount of money that latte was, in the long run, costing the person who was drinking it.”
That 10 to 11 per cent return. Bach’s original calculation was made during the dot com boom, just short of the millennium, when maybe it was likely stock market investments could see such steady returns. But the number “had no basis in reality, as anyone who was certified in anything financial should have known,” Olen writes. “Bach, a supposed expert financial adviser, did not take inflation or taxes into account.” Over the years, other financial experts have done the same calculation with drastically different results.
None of those figures is anything to sniff at –– who wouldn’t be better off with an extra $1,825 in their pocket each year? –– but they aren’t exactly $1 million either.
We reached out to Bach for comment via email. Here’s what he had to say:
“I take total issue….The Latte Factor is a METAPHOR for how we waste small amounts of money on small things. It’s a teaching method to get people to “re-think” how they spend money, and realise they have more than enough to start saving. It’s not about guaranteed returns, and my books don’t promise 10 per cent returns. And my books show in many cases compounded interest rate examples from 1 per cent to 10 per cent.”
Bach’s certainly not the only established money expert Olen, a full-time blogger for Forbes.com and freelance journalist, drags through the mud in the book. Finance guru Suze Orman herself, Dave Ramsey, and Jean Chatzky are just a few others whose popular tips are torn to shreds. It’ll certainly be interesting to see their reaction once this book hits shelves later this month.
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