When I was in my 20s, I watched my friends living it up. They bought expensive cars, traveled to exotic locales and smoked and drank their money away.
I preferred not to blow money on stuff I didn’t need and contributes nothing to my long-term goals. I didn’t see the point. Spend less is a philosophy that has served me well, and has contributed to the financial independence we enjoy today.
I did enjoy my youth. I had some great friends. We traveled, went out and had great times.
Today, my wife and I do buy nice things – trips, a big-screen TV, nice furniture – because we can afford it. We own a nice house that’s long been paid off. I’ve set my priorities, and buying crap isn’t one of them.
The latte factor
David Bach coined the term “the latte factor” in his book, Finish Rich. It’s the simple idea that the little things we splurge on every day add up to a lot of money over time.
Related article: The latte factor
It’s the frequent restaurant means that make us poor – and fat. The kilometres we drive needlessly in a car we can’t afford. It’s the clothes we buy and the stuff we do to impress people we don’t care about. It’s the expensive coffees we buy several times a week.
A cafe latte costs about $4 – and a few hundred calories. I don’t want to waste the money, and don’t need the calories, so I make my own. My recipe is a quarter of the calories, a tenth of the cost and all of the enjoyment.
Regular lattes are a great metaphor for the excessive consumption that has left us with record debt levels, threatening our families’ financial security. We may not have education savings for our kids, but we’re unwilling to give up the junk we buy.
If you invested that $4 for an eight-per-cent return, in 40 years it would be $98.10. By spending $4 on a latte, you may actually be foregoing $98.10 in future income.
How much money do you waste? Cash-starved people often blow a few hundred dollars a month. A friend told me that for years he spent $50 every week on lunches. He could bag some leftovers, but couldn’t be bothered. That’s $2,500 a year, money he wasn’t using for something that was actually important – proper insurance to protect his family, education savings for his children or retirement savings. After 30 years that $2,500 a year could be over a hundred grand.
While the small things are important, if you want to make a meaningful difference in your financial situation you need to think big. It’s the big-ticket items that are killing your finances – keeping you from saving and threatening your family’s security and your financial future. If you spend less on the big-ticket things – borrowing less – it will leave you with enough money to save, and to afford small luxuries.
Our problem is that we take big mortgages and car loans and then decide how much is left to blow, or save. There often isn’t anything left to put to good long-term use.
Mortgage lenders use an affordability measure called the total debt service ratio. The TDS ratio compares your monthly mortgage costs, property taxes, heating bill and all other loan payments against your gross income. Generally, your TDS ratio needs to be 40 or 42 per cent or less.
I’ll modify the TDS ratio and say you’re in good shape to borrow if your mortgage, housing costs and other debts, plus a 10-per-cent savings commitment, are no more than 42 per cent of your gross income.
Related article: How much debt is too much?
Adding savings to your calculation may price you out of the market, but if you can’t buy a home and also save then you can’t afford the home.
Try to spend less on cars and a house. You can buy used, or buy less car. Instead of looking for ways to move up, move down and save.
Housing devours wealth. More house means more of everything – furniture, maintenance, upkeep, utilities, taxes, insurance. However, what you sacrifice on the house is more than offset by the flexibility you have to pay down your mortgage, save sufficiently and enjoy life.
So, sell a car and enjoy the lattes. Your life will be far better than those others who will struggle financially for a lifetime.