Will Avoiding Lattes Make Me Rich?
Budgeting and thinking about your future self definitely could make you rich.
Many of us tend to spend a few bucks every day on something we really enjoy. It might be a cup of latte from the nearest coffee place, a fancy sandwich from that delicatessen, or a yummy chocolate bar.
But next time you place your order, you might be asking whether your future self will thank you for that purchase. Saving just a few dollars every day on unnecessary spending could make a serious difference to your financial future. It could be the difference between retiring comfortably or not at all.
Giving up your daily coffee spend is often touted by finance experts as an easy way to build a nest egg, but does it really work? Looking at the basic math, spending $3 a day adds up to $90 a month, which is $1,095 a year. It’s a decent sum you could be saving.
At the heart of this strategy is the idea of giving up a pleasure today to benefit yourself years down the line; it’s a concept that many people struggle to grasp. Sacrificing something that’s going to make you happy right now for the chance of a few more pennies in your pension pot doesn’t seem like an appealing trade. We prioritize our current self over our future self. In essence, we prefer to spend the money in the present moment rather than saving it for some vague future goal that we find difficult to imagine.
Is That Coffee Necessary?
There are few things in life that are absolutely necessary. Paying rent and your bills are two of those, buying yourself a coffee is--unfortunately--not. Yet we keep buying coffees.
Sarah Newcomb, behavioral economist for Morningstar, says any time we decide between two things, we picture the scenario in our mind: We think about what will happen if we do A, and what if we do B instead.
But there’s a booby trap in our mental models, says Newcomb; something called psychological distance. “It’s how we measure the ‘space’ where ideas live,” she explains. “Any time you imagine an outcome, that outcome takes place in psychological space.”
And in that space, things that are far away in the future, such as saving or investing for a long-term goal such as retirement, look smaller and less important to us than things that are closer, such as a hot cup of coffee right now.
So how can we beat our behavioral biases?
Set a goal. It’s hard not to prioritize your present-day self when your future self hasn’t made any plans. Set some savings goals so you have something real to work toward, whether it’s putting money aside for a house deposit or increasing your pension contributions. Having a tangible target makes saving much easier.
Do the math. That $3 spent today may not seem like a lot, but if you add it up over the long term you start to get a feel for the impact it could have. That $3 a day becomes $1,095 a year, and if you invest that and it grows at 5%, after 10 years you’ll have $14,228. Just because you didn’t buy that coffee.
Use nudges. Technology makes a lot of things in life easier, and saving is no different. A number of banking apps now offer to automatically round up your spending to the nearest dollar and put the difference into your savings account. So, if you spend $2.88, for example, the purchase is rounded up to $3 with the extra $0.12. It doesn’t sound like much, but over a year it adds up.
Beating Your Biases
Mike Coop, portfolio manager at Morningstar Investment Management, says, “Not buying a coffee every time you want is deferring gratification, but above all, it is a test for people to self-discipline.”
He suggests that rather than giving up little luxuries entirely, that it’s better to think of them as rewards for a special occasion rather than part of your daily routine. “That way you will enjoy it more and it will make you pause before buying anything unnecessary,” says Coop. Even if you buy one coffee a week, rather than one a day, that’s $78 saved each month.
He adds, “What does not seem a lot today, such as investing just $3 per day, could build up to a decent sum in the future.”
Indeed, compound interest is your greatest ally when saving little and often. Given time, the phenomenon and earning interest on your interest can supercharge your savings pot. So the earlier you start saving, the less you have to set aside.
That $78 invested each month over 40 years, grown at a rate of 6% a year, could grow to a sizable pot of more than $156,000. And that’s something your future self will definitely thank you for.