Updated on 05.06.07

# The Automatic Millionaire: The Latte Factor

This week, The Simple Dollar takes a look at David Bach’s The Automatic Millionaire. I enjoyed Bach’s earlier book, Smart Couples Finish Rich, but will I like this one, too? Let’s find out.

Yesterday, we discussed Bach’s “pay yourself first” concept, in which an individual should put money away for their future before considering any sort of living expenses. This presents a problem for many people, however, as their living expenses often match (or even exceed) their income.

To solve this quandary, Bach introduces something he calls the “latte factor,” and uses a lengthy story to explain the concept. Basically, the “latte factor” refers to the tiny expenditures that you make each day without scarcely thinking about it. The name, thus, refers to the daily purchase of a latte.

Here’s an example from my own life that demonstrates the latte factor quite well:

When I was first starting out in professional life, I would start off each day with a latte and a bagel, costing together about \$5. I would also hit the vending machine a couple of times each day at a cost of about \$2 a visit. On my way home, I often would stop for a snack of some sort, adding up to about \$3, and about two days a week would stop at the bookstore, averaging \$10 a visit. Little expenditures, right? In a single seven day week, that added up to \$80. Over a year, that comes out to \$4,160. Investing that amount each year at 10% annual return until I was sixty five came out to \$1.92 million dollars.

In other words, that morning coffee and that occasional new book was stopping me from becoming a multimillionaire.

So, if you cut out the latte factor (even partially) and invest that money each month, you can wind up quite rich in the end thanks to the power of compound interest.

Obviously, there are a few minor caveats here: inflation will reduce the actual value of that \$1.92 million (meaning that a dollar then won’t be worth what it is today), and you’re anticipating always being able to put that amount away every single month, no matter what. On the other hand, even with some strong inflation, two million dollars is a nice nest egg.

Tomorrow, we’ll look at some applications of making this automatic.

The Automatic Millionaire is the thirteenth of fifty-two books in The Simple Dollar’s series 52 Personal Finance Books in 52 Weeks.

1. MossySF says:

Inflation will continually increase the nominal amount invested every month. That \$10 “Latte” will be \$12 in 5 years, \$14 in 10 years and so on. On the otherhand, the initial \$10 amount though does have the biggest impact since it has the longest time build up through compounding returns. The final effect of inflation depends returns — the higher the returns, the smaller the gap is between inflation reducing the final real amount and inflation increasing the amount invested.

2. 3bean says:

Trent- I’d like to hear your opinion on the major differences between Smart Couples Finish Rich (SCFR) and the Automatic Millionaire. I’ve read both but it felt a little bit like I was reading the same book twice.

Don’t get me wrong- he’s a little cheesy, but I like Bach. SCFR was one of the first personal finance books I read, and it taught me a lot of basic personal finance knowledge (difference between a 401(k) , Roth, etc.) I read the Automatic Millionaire a few weeks later (it takes all of 1 hour to read), but felt like it didn’t have any new concepts. What are your thoughts?

BTW- thanks for the post of the Coupon Broker. I placed an order with Kirsten this morning.

3. Trent says:

3bean: I’ll write about this on Friday in my “buy or don’t buy” recommendation, but I can say that you’re pretty much spot on. So guess what my recommendation will be…

4. A 10% average annual return until you are 60 is also optimistic. Most use 8% or less in their calculations.

5. Trent says:

Mossy: that’s true, but many people set up deposits for X dollars and let them sit, not adjusting for inflation.

MDJ: I agree, but Bach continually uses 10% in his books.

6. MossySF says:

It’s interesting — I hear the “8% is a more accurate projection” statement all the time. Historic data (based on most large cap indexes) from the last 120 years all show the market has returned about 11% (before inflation). So is this 8% number just pessimism? Or reality because most people underperform the market drastically due to bad stock picks, bad fund picks, high commissions, high yearly expenses and poor tax treatment?

I have a feeling it’s the latter. Maybe you should qualify all your calculations now. If you are a passive, diversified investor with reasonable allocations across all important asset classes and paying no next to no fees by buying low cost index funds/ETFs and optimizing your tax drag, use 10% as your number. On the otherhand, if you are the typical investor who buys 3 different Large Cap Growth fund to “diversify” and then sells in downturns to move to something else that went up already, 8% is your number.

7. I’ll bring up here my perennial problem with the whole “latte factor” savings projection issue: if you don’t buy a bagel and coffee for breakfast, you still need to eat breakfast. Presumably, this means that you’re spending enough more on groceries to cover making breakfast. That takes a substantial chunk out of the savings—it may not halve it, but it does make a difference.

8. Boris says:

I think this only pertains to people who are quite privelaged. I work at a coffee shop and I can tell you that most latte-drinkers drive a Lexus or a BMW, park in the fire lane, and think they rule the world. Most people whose living expenses exceed their income do not spend a penny without thinking about it, therefore, the “latte factor” does not really apply to them. It’s a good though however, if you have the will to strip yourself of your everyday comforts.