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We first heard the term “latte factor” when we read a personal finance book together early in our marriage called “Smart Couples Finish Rich” by David Bach.
Basically, he says look at your small, unnoticed daily expenses, and the easiest thing to do is pick on something like a $5 specialty coffee per day. There are 2 ways to look at the latte factor. Mr. Bach has a formula that says what if you saved that $5 instead and invested it for 10 years at 8% return on investment? So you are forgoing the coffee and investing $150 per month for 120 months. When you add the interest earned, you come up with the number $28,161.88 in this case.
Now you think to yourself, “Is it worth it to give up this frivolous habit, and make an average of $2800 a year extra on my income?” For some people, yes, for others, it’s “Give me my coffee!!!” Keep in mind, it doesn’t have to be daily coffee where you find your savings, it could be monthly or annual expenses like car payments, cable bills, clothing, you name it.
The second way to look at the personal latte factor is I think more realistic. The first way assumes you are taking the saved money and investing it. I think, at the beginning at least, most people would take the saved money and use it to pay down personal debt. So the second latte factor for individuals is simply about opportunity cost.
Let’s say you are taxed at a rate of 30% on your personal income. So in other words, if you make $10,000, the government and others get the first $3,000 and you are left with $7,000. We are using simple rounded numbers here, and remember take-home pay is what you have left on your paycheque after all deductions, not just income tax. So for every dollar you earn at work, you really get 70 cents. Or the other, more powerful way to look at it is, for every 70 cents you want to spend, you have to earn $1 to do so. The formula here looks like:
$ cost = __$ spent___
So a $5 coffee actually costs:
$5.00 = $5.00 = $7.14
As you can see, it actually costs you over $7 in wages to buy that $5 coffee. That means your $150 per month habit actually costs over $210 in personal earnings. So now you can look at that $5 in a few other ways. If you work full time, an average of 160 hours per month, your $5 per day is actually taking $1.34 per hour off your wage! That’s right, a $5 per day, 7 day per week habit costs $1.34 per hour of your working wage at 70% take-home pay. For every $100 you want to spend, it takes $143 in wages earned.
Now everyone’s take-home percentage is different, depending on where you live and how much you make. If you are an employee, you can look at your past few month’s pay stubs and make an educated guess. If your gross pay is $4,000, and your paychecks add up to $3,000, that makes your take-home pay 75% of gross pay. So every $10 spent takes 10 divided by .75, or $13.33 earned.
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