Updated: Jun 12, 2020
The idea behind the latte factor is that seemingly small and routine purchases like buying a fancy coffee can add up to large sums of money over time.
The reverse latte factor is the process of earning extra money beyond your day job. Seemingly small increases in income earned through side hustles can add up to large sums of money over time.
Let's review why the traditional latte factor is mostly irrelevant and why the reverse latte factor is so effective.
Does the latte factor matter?
In the 30-Day Blueprint, I help students break their expenses down three categories.
"The Big 3"
The latte factor would fall under "Stuff". Stuff is anything we spend money on that is not part of our basic living expenses or something that adds value to our lives. My take on the latte factor is simple.
It is a good idea to reign in your spending when you are trying to find money to pay off debt and invest. It's helpful to eliminate as much of the "stuff" we spend money on that provides no value.
However, cutting out the small expenses in its self won't turn your finances around or make you rich. If you want to get serious about saving money, you're going to have to make intentional choices about how much money you are spending on "The Big 3";
The average person spends two-thirds of their take-home pay on "The Big 3". If you want to free up money by cutting expenses, "The Big 3" is the place to start, not your daily latte.
For the latte factor to work, you need to remain disciplined. Not only can you not spend any money on "small things" but you have to automate those savings into investments. You have to maintain that discipline for the rest of your life.
The latte factor has no impact if you only stick with it for 6 months. Is it really realistic to expect that you're not going to spend money on any "small" purchases for the rest of your life?
For that reason, the latte factor does not live up to the hype.
The reverse latte factor
I first learned about the concept of the "reverse latte factor" in a post on The Money Wizard. If the latte factor is about the impact of cutting back your spending by a few dollars per day, the reverse latte factor is about increasing your income by a few dollars per day.
Much like the latte factor, you then automate that additional income into investment accounts.
If you made an extra $300 per month from a side hustle. You would call your bank and ask them to set up an automatic monthly transfer of $300 from your checking account to your investment account.
Can the reverse latte factor help you build wealth?
If you have the discipline to stick with it over a long period of time then yes, the reverse latte factor can help you build wealth.
If you could earn an extra $25 per day or $750 per month from a side hustle and you automated those earnings to an investment account where you earned an average 7% return that would add up to a significant amount of money over time.
After 1 year you would have $9,350
After 5 years you would have $54,000
After 10 years you would have $131,000
After 20 years you would have $393,000
After 30 years you would have $920,000
Why the reverse latte factor beats the traditional latte factor
As I discuss extensively in the 30-Day Blueprint nearly every problem in personal finance can be solved by pulling one of the two levers of personal finance.
1. The income lever
2. The saving lever
99% of money problems can be solved through some combination of making more money (the income lever) and saving more of the money you already have (the saving lever).
The perfect financial plan will allow you to find the sweet spot between these two levers. If your primary objective is to give yourself as much room for error as possible or if you are trying to climb out of a financial hole, you’ll need to focus on pulling both levers as hard as possible.
From a purely "financial" point of view, it does not matter if you are cutting your expenses by $25 per day or increasing your income by $25 per day.
However, it's been my experience that it is easier to convince people that they need to make more money than it is to convince them that they need to cut their spending.
Spending less money means that people will have to reduce their current standard of living. Most people struggle with reducing their standard of living. Once someone gets used to living a certain lifestyle, it’s difficult for them to move backward.
Since the traditional latte factor asks people to reduce their current standard of living, they are more likely to push back against the concept. People don't like it when you tell them they are broke because they spend too much money on the small stuff. We know this to be true when we see headlines like "The personal finance industry is a scam" in reference to the latte factor.
The reverse latte factor asks people to pull the income lever and bring in more income. I have found that most people work hard. Not only do they work hard, they like the idea of being seen as a hard worker by others.
According to the latte factor, you are the reason you are broke.
According to the reverse latte factor, you are the reason you will become rich.
Which of these two messages do you think people are more likely to respond to?
What do you think about the reverse latte factor? Do you think you would be more likely to pick up a side hustle than cut all "non-essential" spending? Let me know in the comments.
This article is for informational purposes only, it should not be considered Financial or Legal Advice. Not all information will be accurate. Consult a financial professional before making any major financial decisions