The Latte Factor was an idea popularized by David Bach in his book "The Automatic Millionaire." The basic premise behind the Latte Factor is that you make small expenditures each day that, over the course of the year, add up to a significant sum.
Bach's core example is that of a morning latte. You wake up, visit your local Starbucks (SBUX) and plop down a few bucks for a cup of coffee. Over a year, $3 a day turns into more than $1,000 in coffee.
These small expenses pile up, and had you consciously made a choice, you probably would've preferred to save that money rather than spend it on coffee.
On the face of it, it sounds like a powerful idea: Find the different ways you are spending money, and start cutting them one by one. Cancel your cable. Brown bag your lunch. Brew your morning coffee. Over the course of a year, you'll save thousands!
While true, it's unrealistic and inefficient.
To take the coffee example, you could buy yourself a coffeemaker, coffee grounds and filters, brew your own coffee and save yourself a few dollars each day. But you'd also have to alter your morning routine to include brewing coffee, and you'd likely not brew a comparable product to a Starbucks cappuccino.
All that to save a dollar a day? That's crazy.
You feel effective because you're doing something to save money, but the actual benefit is quite minor given all the extra work. It's also unlikely that you'll stick with these big changes, especially if it disrupts your normal routine.
What should you be doing instead?
Focus on a) cutting costs that you make unknowingly but could cut without noticing and b) negotiating down as many big expenses as possible.
a) Cutting costs: Start by listing all your expenses and decide which fall into one of the two groups. We all have expenses we pay because we forget: that gym membership we never use, the Netflix (NFLX) DVDs we have piled up on our coffee table -- the list is endless. You need to cut those out immediately.
If you absolutely love your morning coffee, keep buying it. Saving $3 will seem like a pittance when it costs you your sanity. If you don't need the caffeine to start the day, then save yourself the few bucks and put them toward something that matters.
It's about being intentional with your spending. Save in the areas you don't care about so you can spend in the areas you do care about.
b) Negotiate: As for the big expenses to cut down on, you should look for a handful of big wins rather than a million small ones you won't even notice. An easy cost-cutting measure: Take 15 minutes and call up your cable company to negotiate a lower rate. The basic strategy is simple -- threaten to cancel, and wait for their counter offer.
Repeat for any service you pay a monthly or annual fee. The beauty of this strategy is that you can lock in huge savings for an entire year by spending 15 minutes on the phone.
If negotiation makes you uncomfortable, consider this -- everyone else does it. The consumers who don't threaten to cancel and negotiate a lower price are paying more than they should and end up subsidizing other people's costs.
Cutting expenses can only get you so far. In the short term, eliminating expenses is effective and empowering. But in the long term, there's a limited upside to cutting costs, and eventually there won't be anything else to cut.
To truly find financial freedom in the modern age, you need to do more than reduce your spending. You need to increase your income. That could be in the form of investments, such as the stock market or real estate fueled with your savings, or entrepreneurship or being strategic in your career moves.
Unlike cutting costs, growing your income has an unlimited upside.
Jim Wang is an entrepreneur, who founded microblogger.com. For actionable advice on how to build your own business, join his free newsletter.
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