If you tell someone that you are in debt, the first advice most people will offer you is “stop spending”. Occasionally, you will also hear about how David Bach’s “latte factor” is hurting your ability to get rid of your debt (technically the latte factor is about increasing wealth over the long term, but you can also look at it as if it’s about reducing debt over the long term). When I say *stop spending* advice, I am talking about advice of this kind:
If you are facing a debt that’s taking you down in a hole, you need to stop buying those clothes, shoes, junk burgers, coffee, electronic doodads, useless magazine subscriptions, cigarettes, movie subscriptions, and everything else that is not necessary to keep you alive and divert every penny towards your debt. Basically, live like a caveman if that helps.
Those are my own words from sometime in the past :).
While there is nothing wrong with such an advice, things are always easier said than done. The problem lies in the fact that this advice ignores the “happiness factor” completely. Here, I define the happiness factor as the measure of happiness that is associated with some of the things mentioned above (coffee, burgers, clothes, etc.,).
I have been thinking about that lately, and ran some quick numbers on a hypothetical person in debt. The point of this exercise was to compare a *stop spending* approach (or the latte factor approach) with a smarter spending approach towards reducing debt. Hopefully, the series of charts will do all the talking. I will add some comments to highlight a few points of interest.
In the first chart below, there are some (to keep it simple, I have included just a few) of the typical monthly expenses for Mr. DD (Drowned in Debt). Mr. DD is like the rest of us, and enjoys watching a few movies and eating out once in a while. Most of his monthly income goes towards the rent and the car payment.
Based on this, the chart below shows Mr. DD’s calculated annual expenses. Also, his debt is shown alongside so that we have a better perspective of his financial situation.
Now, let’s give Mr. DD a *stop spending* advice. According to this, Mr. DD stops his “latte”…or in essence, stops all his sundry spending on stuff like movies, clothes, etc. This is shown in the chart below. Do you see what has happened? The latte factor is no longer there (he saves $1320), but he has ignored the two most expensive things that he is spending his money on. He applies the $1320 to this debt, and reduces it to $8680. But, he is not very happy here because he has deprived himself of the *happiness factor* while doing this.
Now another smart fellow gives him a smart advice. He tells Mr. DD to look for a slightly cheaper apartment, and a slightly cheaper car. Now, instead of cutting his Latte Factor, Mr. DD decides to follow this advice and spends his money smartly. His annual expenses with this approach are shown in the following chart. Notice that he has reduced is annual car expenses by $660 and rent expenses by $660. Again, he applies the savings ($1320) to his debt and reduces it to $8680. But, this time he is happy because he has been able to keep up with the small enjoyments in his life while doing this.
The other obvious advantage in this approach is that he has reduced those expenses that appear in the form of a long-term contract. Meaning, once he chooses a cheaper car or a cheaper apartment…his savings are automatic over the rest of his contract. It’s not like stopping your Starbucks latte…a little bit of stress and you will be back to Starbucks in the next hour.
To bring this to a closure, Mr. DD’s corresponding monthly expenses are compared to the original expenses below. Notice that by spending his money smartly, he just needs to make minor compromises when it comes to the apartment and the car, instead of stopping everything that gives him happiness.
Hopefully that conveys what I originally intended to convey.
With this, I am not encouraging frivolous spending; I am just acknowledging the fact that there are a few things you need to spend on to keep yourself happy. I am also trying to draw some attention towards the fact that sometimes, we tend to ignore the bigger things that are causing financial problems. In my opinion, we fall for the latte factor quickly because it is much more visible than other subtle (sometimes bigger) problems. Cut the latte if you want, but before you do that, make sure you have taken care of other expensive things in your life. Of course, you could be even wiser and tweak your latte expenses a little bit, but even in that case, your first priority should be to check on the bigger problems first.
Other articles on these lines that may interest you:
-Forget About the Latte Factor : by Flexo @ Consumerism Commentary.
-Want to Save? Give up the Big Things! : by JDRoth @ Get Rich Slowly
Updated: Click here for an interesting counter-arguement by a blogger friend.
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