Summary: The key principle to building wealth is to spend less than you earn and invest the difference wisely. So, obviously, minimising unnecessary spending is fundamental. Yet, when it comes to small, regular lifestyle expenses - takeaway coffees, eating and drinking out, entertainment subscriptions - there are gainsayers who argue that avoiding the small expenses won't make a significant difference to achieving the big financial goals like owning your own home or being secure in retirement.
There are two main categories of gainsayers - people who work in financial services with something to sell, and people who work in the media who publish populist or controversial content (also to make money). Both types are wrong and could care less if offering individuals the best, actionable advice to reach their goals. They have other priorities.
In America, the arguments about what's known as the "Latte Factor" have fully played out and the best universal guides easily dispel all of the smoke and mirror rebuttals. In this post, I'll provide links to these guides and calculators. I'll also provide answers to queries of special relevance to Australians - such as what to do when the cost of property is so high and smashed avocado brunches are so hip.
Basically, it is feasible, on any Australian wage income, to save for useful big-ticket financial goals while still enjoying life. Indeed, the majority of posts on this blog provide specific steps on how to achieve these savings in each area of life - housing, transport, food, utilities, technology, etc. And once you have significant savings you can afford the big purchases that genuinely improve your quality of life or use the yearly income to start funding indefinitely the things that you find most worthwhile - which may include good coffee or eating out with friends.
Gain: Tens of thousands of dollars over your lifetime which can be used for major financial goals or to pay for regular, valued expenses indefinitely.
My Situation: My expenses and financial situation exemplify this approach of eliminating unnecessary expenses, expending the time and effort to live more self-sufficiently, and building up a large pool of savings that will generate substanial annual income indefinitely.
Financial Mentor - Latte Factor
Details:
1. Articles in favour and against the "Latte Factor" as a useful step for achieving your financial goals
In favour of the latte factor:
> Latte Factor Calculator (this is the essential, universal guide)
> Moralisers, we need you! (Bernard Salt)
Against the latte factor:
> Buying Coffee Every Day Isn’t Why You’re in Debt
> Baby boomers have already taken all the houses, now they're coming for our brunch
> Are millennials actually bad at saving or are houses just unaffordable?
> Avocado wars: enjoy your brunch but earn earlier
2. Does the Latte Factor maths stack up in terms of savings?
All critics of the effectiveness of small and steady savings in building wealth are bad at maths, terrible at personal finance, and usually dishonest as well. For example, Brigid Delaney recently offered the below analysis of whether Bernard Salt was correct in asserting that "twenty-two dollars several times a week could go towards a deposit on a house."
Hey, Salt – your maths is wrong! Houses prices in Sydney have surged beyond the price increases of smashed avo with feta on sourdough. The median house price is $1m. You would now have to save $200,000 to put down a 20% deposit on something not great, somewhere not grand.
Forgoing avo on toast for brunch once a week and you’ll save for your deposit in ... 175 years! That’s 9,100 $22 smashed avocados on toast. With feta. And maybe some chilli flakes.But it is Brigid who's maths is horribly wrong.
Baby boomers have already taken all the houses, now they're coming for our brunch
- Bernard Salt wrote $22 several times a week, not once a week.
- The biggest gains from saving come from compound interest, yet Brigid ignored interest entirely.
- Houses are bought by couples who save on two incomes so the saving side should be doubled.
- Boom-bust asset prices pumped up on debt and speculation with record low interest rates cannot be compared to food prices. One can choose when buying a first home makes sense and at what cost. Gambling with asset bubbles is wholly optional. So arguing the price of entry into home ownership is $200,000 or you can forget it is just silly.
The Guardian then produced it's own calculator to add some ease to the calculations:
At $100/week, 23-27 years is a lot less than 175 years. But even this calculator understates compound returns by using an interest rate of just 2.7%.
Using the Latte Factor Calculator we can use a more realistic 5% return over the long term and find the time required is down to 21.5 years:
3. The Latte Factor is not about your most valued regular expense (e.g. brunch with friends) but about all of the unnecessary regular expenses you could eliminate if you wanted to save for a larger financial goal
Those who want to dismiss the effectiveness of frugality, simple living, consistent saving and wise investing always try and reduce the Latte Factor argument to a single expense like your workday coffee or Sunday brunch.
But it's easy to justify a single discretionary expense you find very worthwhile and hard to replace with a more frugal substitute.
The truth is that virtually everyone who struggles to build significant savings has dozens of regular expenses which could be eliminated or substituted. All one has to do is go through 3-6 months of their spending transactions (including cash) and they will appear:
3a. Wholly unnecessary expenses that deliver no value
- Interest and charges on debt (e.g. credit cards)
- Parking and traffic fines
- Unnecessary fees for late payments, rejected transactions, etc
- Unnecessary insurance
- Subscriptions you don't use or get value from (newspapers, digital services)
- Paying storage fees for items you should sell or give away
3b. Unnecessary expenses that can be replaced with effort or time
- House cleaner
- Most personal services
- Uber, taxi and parking fees
- Gym memberships
- Finding the best value-for-money products and services (energy, internet, health insurance, appliances, etc)
3c. Unnecessary expenses that at most involve a sacrifice of status
- Getting a cheaper or second-hand phone or laptop and not upgrading unless necessary
- Getting a cheaper phone plan ($20/month rather than $60/month)
- Not buying status products like clothing, shoes, accessories, gadgets
3d. Expenses that can be replaced with frugal or simple living substitutes
- Cooking at home and taking your lunch to work
- Eating and drinking at each other's homes or in parks
- Socialising via outdoor activities rather than only eating and drinking
- Replacing Pay TV or Netflix-type subscriptions with free alternatives or finding different leisure activities
- Getting exercise and playing sport via free, outdoor activities
- Replacing gambling with low-cost activities that feed the same impulse (e.g. social card games)
3e. Valued expenses that might be sacrificed only because of a superior goal (like saving for a house deposit)
- Cutting back on takeaway coffees and eating out
- Cutting back on the expense or length of holiday travels
- Cutting back on alcohol costs when socialising
- Cutting back on the cost of recreational and sporting activities
These are just a handful of examples. There are actually dozens of opportunities to eliminate or reduce regular expenses. It is disingenuous to pick just one valued expense (like weekend brunch with friends) when there are so many easier ways to save which involve less sacrifice of things that are defensible.
For example, many people spend more on unnecessary fees and fines (ATMs, late payments, dishonoured transactions, parking and traffic fines, etc) than on brunch each year. But they conveniently ignore such expenses when justifying why they can't save or why their expenses are worthwhile.
Once you start to add together the expenses that deliver the least value and are most readily replaced, it is easy to see how saving a much higher proportion of one's take-home wages is possible. Instead of reaping only $22 a week, many people could easily harvest $200 a week.
Then we simply double that to $400 as most homes - especially $1 million ones - are bought by couples who both work to save up. Now the maths looks a lot different:
Now it only takes 8 years for a couple to save a $200,000 deposit. Quite a difference from the 175 years Brigid calculated. And that's only using the savings from regular, small expenses. The major savings come from the big lifestyle decisions covered on this blog like eliminating debt and fees, walking and cycling instead of owning a car, and the many ways to save on housing costs (sharehousing, housesitting, etc).
And sure enough, even mainstream couples who have never heard of simple living can manage to save $200,000 in 8 years. See: Sydney First Time Home Buyers Face Saving For Nearly Eight Years
But a couple - each earning the average Australian full-time wage of about $70,000 - who follow the relevant savings steps outlined on this blog, should be able to save $1,000/week. And here's where the cumulative value of eliminating unnecessary expenses really pays off.
Over the same 8 year period we now have three examples:
- The argument espoused by Brigid that saving for big goals is pointless and there are no worthless expenses to cut. The result being negligible savings.
- The example of the mainstream couple who commit to a large, motivating savings goal and get $200,000 in 8 years by just doing the obvious stuff but also making some real sacrifices.
- The simple living approach exemplified on this blog where you can easily reach high savings rates (50%+) and save $510,000 in 8 years while still enjoying life, just in different ways to the mainstream.
The reason why the initial post on this blog primarily centres on a breakdown of my regular expenses - notably all of the expenses I don't have - is because this is the easiest way to see all of the opportunities to build wealth through spending much less than you earn.
See: The single page guide to financial freedom in Australia
4. Minimising regular expenses to the extent that they reduce your enjoyment of life is pointless. Your youth should be enjoyed. But even real sacrifices can easily be justified based on your own relative judgements. You need your own medium and long term goals
The examples in point #3 above as well as the steps in this blog provide many ways to minimise unnecessary expenses in ways that don't reduce your enjoyment of life. There is plenty of pointless fat to be cut before you get to real sacrifices.
However, I do not recommend taking the expense-cutting to the extreme in order to accumulate as much savings as fast as possible. Life should be enjoyed, the purpose isn't to die with the fattest wallet. The danger is that unless you are strongly motivated to put off instant gratification and save, it's easy in modern society to simply spend almost everything and chalk it up as enjoying life.
The strong motivation comes from the medium and long term goals you really strive for. Owning a big home isn't everyone's dream. Your dream might be to quit work and go travelling for a few years like this New Zealand guy:
He said he had lived in a large house with a group of friends to reduce rent and expenses. He rode his bike to work and for any small errands, used his modest car as little as possible - and learned how to drive it efficiently, while also sharing it and the expense with a flatmate for a while.
Taking pre-made lunches and cutting out bought coffee helped, too. He went out to restaurants and bars less often and instead had friends over for food and drinks at home, or went to their houses. His beer was home brewed, he always maxed out the duty-free alcohol allowance, and bought wine by the case to keep costs down.When most of your peers are supposedly enjoying life to the max by opting out of home ownership, it's easy to rationalise your current expenses as living well. According to Brigid Delaney this is what living constitutes in modern Australia for young people:
Fancy $100,000 spending money? How one man managed to save thousands for a dream trip around Asia ... and he reveals how you can too
So what do you do when you can’t afford to buy somewhere to live? Well, you decide to live.
You get Ubers, you travel, you buy a good phone, you get a laptop, you go for brunch...
Baby boomers have already taken all the houses, now they're coming for our brunch
To that list, The Guardian also added some other examples of "life's luxuries":
But is brunch, getting around by Uber, having the latest iPhone or MacBook, takeaway coffee, pub beer, fast food, yoga classes, quinoa, Netflix and holidays in Bali really living well? This kind of living may provide short-term pleasure but offers little lasting fulfillment or quality of life. It also seems driven by conventional norms and status anxiety. What about your own priorities?
I'd argue relative judgements about value-for-money are important and you should calculate them properly often enough so that you develop a good handle on the opportunity cost of your choices. If you have motivating medium and long term goals that require bigger savings then this provides an important way to benchmark the cumulative expense of a daily or weekly habit.
In simple terms, the blog Afford Anything nails this point - blindly adopting your peer's expensive habits is what holds you back from achieving your own bigger goals:
#1: You Can Afford Anything. You Just Can’t Afford Everything.
Don’t tell me your values. Show me how you spend your money, and I’ll know what you value.
Don’t tell me, for example, that you “can’t afford” to save money, travel or invest if you’re simultaneously buying nice clothes and hitting the bars.
There’s nothing wrong with clothes and bars as a deliberate, conscious choice. But don’t claim that bigger goals are out-of-reach. Don’t utter the self-defeating phrase “I can’t afford it.” That’s weak. It’s disempowering. It’s a limiting belief.
Instead, ask yourself: “How do I afford everything else in my life? How do I afford my iPad? My new-ish car? My restaurant habit?”
There’s nothing wrong with buying an iPad and enjoying a five-star meal. The problem emerges when you blindly adopt those habits while simultaneously claiming that you “can’t afford” something else.
The 12 Essential Lessons You Must Learn About Money & Life
5. Forget mainstream goals and pursue useful savings goals that genuinely add to the quality of your life in the most efficient way
Much of the analysis of the inflated price of housing in Australia's large cities - particularly Sydney and Melbourne - is actually valid. I recommend not buying property when the Price-to-Rent ratio is over 20 and in the most desirable parts of Australian cities it is way over 20.
See: Understand how to use rental yields to determine if buying really is cheaper than renting
But the logical conclusion is not to opt out of accumulating large savings at all. It's to ensure you are pursuing goals that genuinely add to your quality of life. An expensive house and massive mortgage does not do that.
But there are many useful ways a significant and growing savings fund can improve your quality of life in lasting ways:
- You can afford to rent a more comfortable home, closer to work, in a location that is safe, walkable, bikeable and has lots of amenities. If house prices drop dramatically anytime in the future you can choose to buy when it most makes sense in terms of value and your circumstances
- You can afford to make your long-term rental more comfortable. Such as negotiating to fund better insulation, an efficient reverse cycle air conditioner or other worthwhile improvements
- You and your family can have a strong safety net against the uncertainty and anxiety of health issues, unemployment or other adverse events
- If you have children, you can afford to take considerable time off work or work part-time
- You can create a buffer to negotiate better pay or flexibility in your current job
- You can give yourself a mini-retirement and time to learn new skills, switch careers, or try starting a new enterprise
- You can permanently downshift to part-time work and spend the other days on hobbies, personal projects or leisure
- You can afford to pay indefinitely for your most-treasured luxuries (coffee, avocados, craft beer, etc) if you obtain them in value-for-money ways
6. Minimise unnecessary spending early and build up savings and you can later fund the desired value for free indefinitely
Familiarising yourself with the long-term maths of different decisions, and also starting to save in a purposeful way, can lead to actual, long-lasting improvements in quality of life. The trick is to minimise unnecessary and low-value spending early so that you accumulate a large savings fund that can in future pay for the desired value (good, service) indefinitely from investment returns.
For example, in the below post on saving energy costs, I explain how one can dedicate the cumulative savings from eliminated expenses to specific categories, such that their annual investment return can ultimately pay for ongoing costs indefinitely.
Instead of trying to run our own gold-plated energy infrastructure we just keep that $20,000 invested and it yields at least a 5% annual return ($1,000). Indeed, our cumulative savings from not wasting money on such bogus "household investments" over many years are much higher than $20,000 and the annual yield will permanently cover all future energy bills.However, my favourite examples with respect to the Latte Factor are on worthwhile values like music and books.
Avoid cost-saving investments that will never actually pay off
If you avoid paying for a vinyl record collection (great status, low value way of listening to music) at say $20 per week for 5 years while it's still cool with your peers you will save $5,893.
Then just leave that $5,893 invested but start spending the annual investment return (~$300) on the actual desired value - listening to music - by purchasing a Spotify membership at $12/month. You now have free music for the rest of your life!
The same approach applies to many worthwhile values:
- Books (e.g. funding a yearly Kindle Unlimited membership through using libraries rather than buying books for 5 years)
- Coffee (e.g. funding an espresso machine by limiting takeaway coffee purchases for a few years)
- Tasty and healthy foods that are expensive like avocados, berries, nuts, cheeses (e.g. funding their regular purchase for meals you prepare at home or in a park by limiting, for a few years, how often you eat out and how much you spend)
7. Real estate tips from the terminally ill
UBank - NAB's online bank - is the best bank to use in Australia (lowest fees, best rates). It also has an interesting focus on quality of life in its recent campaigns. One of them is: Home Truths - Real estate tips from the terminally ill
UBank encourages Australians to borrow less and live more. It’s a provocative statement and one we stand by in hope that we all can take a moment to think about what’s really important when it comes to our money. And, then spend that money wisely against those priorities. To bring this to life, we spoke to group of people who provide a unique perspective on what’s truly important in life. ‘Real estate tips from the terminally ill’ is a film we’ve put together with words of wisdom from six people living with terminal illness.
The insights were telling. Each person, after receiving their diagnosis, experienced a complete shift in perspective. With the knowledge they were nearing the end of their lives, they were able to focus on what is truly important and let everything else fall away.If a bank - which makes most of its money from lending - can admit that living well doesn't depend on owning things and it can, in fact, be counterproductive, then it's time those who think living is about spending woke up as well.
Julie, one of the interviewees in the film, shared her insights on just that by saying it’s great to have nice things, but if you’re stretching yourself financially to obtain them, that’s when you need to re-evaluate your approach.
Our hope is that after you watch the film you will consider reviewing your own approach to spending your money on the things that are most important to you. Are you spending enough time with family and friends? Are you pursuing what you’re truly passionate about? Are there changes you need to make to find more time for your priorities?
The final thought from the film that I want to leave you with is one that was beautifully put forward by Karen in the video; Humanity isn’t about the bricks and mortar, it’s what is inside those bricks and mortar.
Further Info:
Lifehacker
> Revisiting The 'Latte Factor' And The Power Of Daily Routines
The Guardian
> I could get outraged by this boomer-millennial war, but I'd rather look at the evidence
Huffington Post
> The Smashed Avocado Furore Came Up In Parliament Today
Junkee
> We’ve Defended Smashed Avocados, Now It’s Time To Fight For Houses, Free Uni And Better Jobs
SoundCloud
> 702 ABC Sydney - 30 minutes of entertaining generational debate.. Boomers V Millennials
The Australian
> Moralisers, we need you! (Bernard Salt)
> Millennials react to Bernard Salt’s attack on smashed avo
The Monthly
> The boomer supremacy
Macquarie
> How to save money without giving up your daily coffee
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