The Retirement Latte

Photo: ny156uk

My introduction to David Bach was when I saw him speak at a financial conference a few years ago. He told an interesting story about a couple who came in for a consultation with him when he first worked in personal finance. They were in their mid 50s, had two children who were fully put through college, had two properties fully paid off, and were ready to retire with over $1 million in savings. The impressive factor was that they had managed to build and sustain this comfortable financial position with a relatively small family income.

Bach simply didn't understand how this couple had managed to do so well for themselves, so he asked them. Their response: A lifetime of prudent saving and investing, paying themselves first each month.

As most of us know by now, budgeting, saving money and accumulating for retirement or major purchases doesn't have to be a soul-sucking life-altering commitment that means years of total sacrifice. But neither does it mean spending on our every whim. There is a wonderful balance between enjoying what today has to offer, and making sure that tomorrow will be taken care of as well.

I was impressed enough with David Bach that I read his book The Automatic Millionaire , and continued to enjoy his message and clean style.

Both in his book and on his speaking circuit, Bach mentions encounters with people who understand his advice, but find some reason why they can't start saving money now. They argue that sometimes it's impossible to get ahead and stop living from hand to mouth.

In answer to this Bach starts to dissect their daily routines with them. He discovers that rarely do they eat breakfast at home; they instead get a muffin and latte at Starbucks on their way to work. They might pick up a mid-morning booster juice of sorts, and half the time end up buying lunch too. That quickly adds up to at least $15/day spent on things that arguably didn't enrich their lives so much that they couldn't see their way to altering at least a few of these habits.

Bach has nicely summed this concept up into The Latte Factor. He argues that if you take the cost of a latte and muffin each day ($5 x 7 = $35/week, $150/month) and invest this money at a 10% rate of return, after 40 years you would have a whopping $948,611. (Interestingly when I plugged these numbers into his personal latte factor calculator , the number instead came to around $880,000).

Prudent investors might balk at a 10% annual average rate of return. The same strategy at a more modest 8% annual average rate of return would accumulate just less than $500,000. That's significantly less than what Bach's Latte Factor would have for us at the end of the day, but still a heck of a lot more than what we'd have if we just had consumed that latte and muffin every day instead!

In any case, I found Bach to have a great style both on stage and in his books. His writing is fairly casual, informative, entertaining, and his series of books are extensive enough to apply to just about anybody.

And for our Canadian readers, he has adapted many of his books to include the finer points of Canadian tax laws and investments into his material.

Some people will find his suggestions to be common knowledge or nothing new, while others will see their finances in a new light. As with any financial advice, it is always best to do your research, understand advice coming from the source (in this case a book) for what it is, and get a second opinion.

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Guest's picture

Great post. David Bach is one of my all time favorite motivational speakers and writers. His simple interpretations to investing goes a long away. I also recommend his books.

Guest's picture

Where Bach completely misses the boat is his emphasis on the small stuff. Cutting out $5 a day is fine but it is the big financial decisions that will ultimately sway the day in terms of financial health.

He often employs rather unrealistic x factors to make his points more dramatic and seemingly powerful. For example, as the original poster stated, he uses an average of a 10% a year compounded return to inflate the effects of his strategies.

Maybe instead of figuring out how you can squeeze another $1.25 in savings a day people should concentrate their efforts on figuring out how to get a raise or finding a better paying job. Maybe instead of cutting back to seeing movies in a theatre six times a year to three they could focus their attention on analyzing their investment decisions, educating themselves about various investment vehicles and focusing on those areas that will have the largest impact on their financial life.

I'm all for the concept of living well below your means. I am all for pushing forward the idea that it isn't necessarily how much you make but what you do with it that counts. But his philosophy has people focusing on the pennies when they should be concentrating on the dollars.

Guest's picture

Why does everyone balk at 10%? If you look at the average rate of return (including reinvesting dividends) for the S&P 500 since 1970 it comes to ~11%. I have found numerous mutual funds with 15+ year histories that have an rate of return since inception greater than 12%, so I don't know why people shoot for 8% when just investing in an S&P 500 index fund could get more than that.

The Russell Midcap Value Index has a 10-yr annualized rate of return of 11.70, and the Ariel Fund has a 13.44% annualized return since inception (1986). If you go to Morningstar you'll find that there is a large list of funds with a 10-yr rate of return Greater than 15%. These include funds from fairly well known companies like Fidelity, T.Rowe Price, Vanguard, and Oppenheimer.

Guest's picture

between 1964-1978 stox didn't move much.

Nora Dunn's picture

You make great obervations, Andrew. Very well-researched and documented. Thank you!

The reason why I (and I imagine others) tend to balk at a 10% avg annual rate of return is that most people don't invest 100% of their portfolio in equities. To do so isn't necessarily wrong as equities are arguably the best way to get a good rate of return over inflation in the long run, but constitutes an aggressive investment strategy which many people don't quite have the stomach for.

And heck - wouldn't you prefer to be safe than sorry? I'd rather count on 8% per year and possibly make more, than count on 10% and possibly make less. 

Guest's picture

I have been a fan of Bach's writings for a few years now and have recommended them to many people. I also like his clean writing style and humor ~ I've read The Automatic Millionaire twice. He offers sound advice without speaking over your head. Most people I know fear the subject of personal finance because of feeling under-educated on the subject. I feel Bach takes away that fear factor and shows that these financial goals are easily attainable without having to be a CPA!

Guest's picture

Although I haven't personally run the figures in the example given above (and copied and pasted, below), I presume the difference between Bach's calculation and Dunn's relates to compounded interest.

He argues that if you take the cost of a latte and muffin each day ($5 x 7 = $35/week, $150/month) and invest this money at a 10% rate of return, after 40 years you would have a whopping $948,611. (Interestingly when I plugged these numbers into his personal latte factor calculator , the number instead came to around $880,000).

Of course there are a lot of assumptions. How often are deposits made? Is interest calculated daily, weekly, monthly? But the point remains... delayed gratification can have its benefits.

(Okay so I couldn't help myself and DID run the calculations with the use of an online calculator. Assuming $150 a month at an interest rate of 10%, the calculator suggested the final amount would be: $948,611.94.)

Guest's picture

I think one reason Bach might have used 10% in his books is because it sounds nice and, for a good 10 years, it seemed like a normal investment return. Also, that way he can motivate people by telling them they can accumulate a million bucks (That's in 2048 (the year) dollars, which are only worth about 33 cents each, by the way) by cutting out coffee visits. Even if it's not completely realistic, it's reasonable of him to do since a lot of people don't "do" compound interest and don't know present versus future values. If it gets people motivated to make a positive change in their lives, I say great. Wiser and more knowledgeable heads (like Warren Buffett) know that there's no way for most people to average anything close to 10% per year. Try maybe 6 percent. And those are pre-inflation numbers. Then take out inflation at 3% a year and the numbers look a lot less impressive to the uneducated eye. So Bach just dangles the obvious numbers in front of people. That's all right in my mind if it helps them get off their butts and improve their financial stability and future.

Essentially, some of us are we're arguing over whether you're going to get 900,000 or 400,000 by cutting out coffee breaks. Well, either one of them is a lot more than zero, which is your other option. Even if you state it correctly, in inflation adjusted terms,(and few pop finance writers seem to want to do that) and the 400,000 in 2048 dollars turns out to be worth $133,000 in 2008 dollars, I suspect you'd rather have that than nothing.

It's also essential to look at the income side of the equation, and earn enough, because if you don't have enough income then no amount of frugality will pad your nest egg. And yes, even if you earn big $$, if you don't curb your spending, you can easily fritter it all away and end up with no cash at the end of the journey.

I'd take a round guess and say a half a million in today's dollars, by the time you are 60, is the lower end of money that would allow for a secure retirement for an individual. (couples would have a slightly different figure, probably more like 750,0000. So, to my mind, the litmus test question is, "given my current net worth, my income, and my current rate of savings, will it add up to half a million in today's money? " If so, great. If not, I'd be thinking about making serious changes pronto.
I'd say most of us would do well to cut out the bar runs and cafe trips, the unnecesary clothes shopping and the Disney channel subscription, and pay attention to this.

And if you take a cold analytical look at your own numbers and see that you're not on track for that 500,000 in 2008 dollars, now might be a good time to start by doing something as easy and painless as making your own coffee and muffins.

Guest's picture

The “latte factor” is complete nonsense. The people that promote largely overstate the final numbers you can save for retirement. After considering taxes, inflation, decreasing rates of return as we near retirement, it doesn’t help out as much as people would like. Retirement is a much more difficult game than just skipping out on lattes. See more accurate measure of what you would save here …