David Bach is the author of the best-selling Finish Rich series, and the latest is The Finish Rich Dictionary: 1001 Financial Words You Need To Know. Bach defines essential financial terms and provides 10 helpful essays with topics ranging from understanding a credit score to planning for retirement. In the excerpt below Bach explains why skipping your morning latte may be the key to future riches.
The Latte Factor is a concept that represents the amount that people spend every day on items such as a double nonfat latte, cigarettes, soft drinks, and candy bars, which they could instead save and invest for their future. If you purchased a $3.50 latte every day for a year, for example, you’d spend $1,260; over a decade, $12,600. If you invested that money at 10 percent over 10 years, you would wind up with $21,870.
You may wonder what good it will do to put aside a small fraction of your income, especially if your income isn’t very large to being with. But even if you earn what seems to you a modest salary, the amount of money that will pass through your hands during your lifetime is truly phenomenal. If you earn only $1,000 a month, for example, you will have made a total of $360,000 over the course of 30 years. If you earn $4,000 a month, you’ll make more than $1.4 million over 30 years.
So, even though you may not receive much in each paycheck, you’ll accumulate a substantial amount over time. And the sooner you start saving some of it, the less you’ll need to put away. That’s because of the magic of compound interest.
Albert Einstein called compound interest “the greatest mathematical discovery of all time.” That’s because compound interest helps you earn more money not only on your own hard-earned savings, but also on the interest your saving accumulate. In the first year, for example, you earn interest on your initial investment. The next year, you earn interest not only on your investment, but also on the interest that you’ve already earned.
Compound interest has all sorts of implications for saving money. For one thing, if favors people who start saving at an early age. If you start at the age of 25 to save $100 a month, and it earns interest at a rate of 4 percent, you’ll accumulate $118,590 by the time you turn 65. If you wait till you’re 40, you’ll accumulate only $51,584…
Think about what you bought today that you could do without and start saving a few dollars. It might be something that you’re in the habit of buying every day, like two double nonfat lattes and a couple of nonfat muffins. If you cut these out of your daily spending tomorrow, how much money wold you save a day? How much would it save you in a month? This is your personal Latte Factor, and it can quickly add up to a lot of money…
Remember-the combined power of the Latte Factor and the miracle of compound interest is truly amazing. The only thing that can short-circuit it is the all-too-human tendency to procrastinate. Too many people put off doing what they know they should, and as a result, these two powerful tools never get the chance to work for them. Don’t make this mistake.