Compounding Your Starbucks Lattes

In North America, you know the holiday season is in full swing when you are able to order pumpkin spice lattes at Starbucks. Most of the time, you will know exactly when pumpkin spice will be available because just about all news media outlets and social networks will comment on this caffeinated annual event. How did a seasonal coffee beverage end up becoming a pop culture phenomenon? You can probably blame financial author David Bach, a former fund manager at Morgan Stanley, and his penchant for injecting his prose with Starbucks latte allegories.

“The Latte Factor”

Bach’s first best-seller, “Smart Women Finish Rich,” was published in 1999, just a few years before the bursting of the Dot-Com Bubble. This was the first time the “latte factor” was mentioned. There is a good chance you have read or heard about this: A Starbucks junkie who spends $5 each day on lattes would be better served by skipping that treat and instead placing those $5 into a stock portfolio growing at an annual rate of 11%. Bach often uses young women for his financial scenarios, and in 1999 he argued that these hypothetical investors could turn her latte obsession into $2 million by the time she hit retirement age.

Since his first book went on sale, Bach has published a few other best-sellers, and they all mention the latte factor; in fact, his most recent book is titled “The Latte Factor,” which also happens to be the name of his podcast. In terms of financial advice and engaging prose, you will never go wrong with Bach; however, his original latte factor was not only hyperbolic but also miscalculated.

The Realities of Investments for Retirement

When evaluating the performance of the stocks Bach recommended in 1999, and when taking into account other variables such as cost of living, inflation, and capital gains tax, the actual savings came under $200,000. If Bach had recommended investing in a benchmark index fund tracking the S&P 500 or the Dow Jones Industrial Average, the returns would be much better, but still far below $2 million.

With compound interest, a 22-year-old latte fiend who turns the $5 caffeine into an investing strategy could realize about $1.5 million when she turns 65, but this is with an annual percentage yield of 11%, which is not so easy to find at a time when the Federal Reserve has slashed interest rates. The bottom line of the latte factor is that saving and investing instead of drinking expensive coffee all the time is a sound financial strategy, particularly when your savings are earning compound interest.

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