The “Latte Factor” is a Lie

An Australian millionaire sparked a meme when he said millennials would be able to afford houses if they would stop buying avocado toast.

Perhaps Tim Gurner will be credited for coining a new term in economics―the avocado toast index. How many avocado toasts does one need to forgo to save up for a down payment on a house?

The question arises out of a demographic problem. People between ages 25 and 34 are trailing previous generations in home ownership in the U.S.

Owning property is an integral ingredient to building wealth. When you buy a house, you lock in a fixed mortgage payment (whereas rent can keep increasing). You increase your equity with every payment, making your property function like a savings account. Plus the value of property generally increases. Property is a tangible asset, a safer investment than stocks or, say, cryptocurrency. If you pay off the house by the time you retire, you have a place to live and no mortgage payments, so ideally your cost of living will be manageable on a fixed income.

Do millennials and Gen Z-ers face more challenges than their forebears, or are they entitled and squandering their money on avocado toasts and lattes?

The latte factor theory

David Bach, a writer and personal finance guru, coined (and copyrighted) the term “latte factor,” which states that spending a small amount of money on unnecessary luxuries over time adds up.

Nothing earth shattering there, but his theory creates a formula where you take the cost of this daily expenditure and figure out how much you’d make if you invested that money instead.

The latte factor puts a number on opportunity cost. Any time you spend money on one thing, you lose the opportunity to use that money for something else. When you buy something, you lose the opportunity to use that money for something else, such as saving or investing.

Take the cost of a daily latte, a conservative $3, invested with a 7% return. It would yield $16,188 in 10 years, according to Bach’s calculator.

Yet writer Helaine Olen says the latte factor is bullshit.

Bach knew his archetypal latte guzzler could not be spending $5 on a single latte, not in 1999. So he added a biscotti to the bill and factored in the incidental Diet Cokes and candy bars he assumed his subject also bought. Even then his numbers didn’t quite add up. Five dollars a day, 365 days a year is $1,825. So Bach “rounded” the number up to $2,000 annually, the better to exaggerate the amount of money that the latte was, in the long run, costing the person who was drinking it.

Bach’s assumptions about stock market returns were overly rosy too, says Olen. Plus he didn’t factor in taxes or inflation.

For people living paycheck to paycheck, deep in debt, forgoing dinner once a week with a romantic partner or friends isn’t going to make a huge difference financially in the long run, but could make a huge difference in stress management and mental health.

Speaking of health, know what can make a huge difference in a person’s financial state? Huge medical bills. Or huge student debt. Or stagnating wages as the costs of housing and education balloon. Olen writes:

In the view of researcher Jeff Lundy, who wrote a paper on the phenomenon, the spending, while a problem in that it caused a decrease in one’s financial reserves, wasn’t causing the financial ill winds themselves: “Spending $2 for a latte may, over the long-term, add up. But it is not the direct cause. It has to be in combination with high medical expenses or losing your job or something like that.”

In 1973, housing, education, and health care ate up about half of the average family’s income. By the 2000s, it was 75 percent. Add one emergency―medical problem, job loss, or divorce―and that can turn the world upside-down, no matter how many forgone sushi dinners or lattes.