A reader wrote to me recently and expressed some serious doubt about the “latte factor.”
I understand that I could be putting the money from a $4 latte into retirement but I don’t get why it’s important. I would rather have a latte than have $4 when I’m old.
Let’s break this down into pieces so that the concept becomes clearer.
If you walk into a coffee shop on your 25th birthday and plunk down $4 on a latte, that $4 goes away. If you just took that $4 and stuck it under your mattress for 40 years, you’d just have $4 when you’re 65. But if you took that $4 and put it in an investment that earns 5% (like a treasury note) for 40 years, you would have $28.16.
Okay, let’s say that you drink just one latte a week for just your 25th year on earth. That’s 52 lattes, a total of $208. In that same investment, you would have $1,464.32 when you’re 65.
Let’s say again that you buy a latte a week until your 65th birthday. That’s 2080 lattes, which costs a total of $8,320 (and that assumes the price will not go up for 40 years, which means it’ll be more than that in reality). With that same investment, you’d have $26,590.67 at age 65.
Let’s say that you drink three lattes a week (not unreasonable for a latte drinker). That’s 6,240 lattes, which costs a total of $24,960 (again, with no price increase). If you just buy that same 5% investment, you would have $79,772.01 at retirement.
Now, let’s say instead of buying a treasury note, you put that money in the Vanguard 500, which has earned 12.14% annually since inception in 1976. If we can expect that same return, you will have $558,690.42 at retirement.
Drink a latte daily? You’re losing $931,150.69 at retirement. A morning latte and an afternoon latte? $1,862,301.38.
This is the power of the “latte factor.” It’s not a single choice to buy a latte that’s powerful, it’s a regular purchase of a latte combined with the power of compound interest that makes it powerful. Obviously, the huge numbers quoted here are indeed in future dollars, but even with 4% annual inflation, you’re still tossing away $387,897 in today’s dollars just on your two lattes a day. That’s the foundation of a good retirement, tossed away on a frivolous part of a daily routine.