How to Make the Reverse Latte Effect Work for You - Not Against You
There are entire books about the reverse latte effect, but the concept is simple - small amounts add up over time. It’s easy to think that a few dollars here and there aren’t going to affect your future, and also that waiting a couple years won’t hurt you. But, if you take a look at the numbers, you’ll see that the earlier you start investing into your retirement, the less you actually have to do in the long run.
This comes down to two main factors:
Life is long
Compounding interest
I mostly want to discuss this in the context of retirement, but you can think about #1 philosophically too if you want! (:
Planning ahead now could save you a ton of stress in your 50s, when you’re starting to look forward to your retirement. The last thing anyone wants is to have to work longer than expected, or stress about making it once you finally quit your job. So, let’s talk about some numbers, shall we?
What if you skipped your morning coffee, and invested the cost instead?
Investing money always sounds like a good idea, but I wasn’t convinced that I was “the type of person who invests.” This mostly came down to a lack of role models in my life who invested outside of their retirement accounts.
I looked at the numbers myself - turns out, this is a no-brainer. You don’t have to be a millionaire to start investing, but you do have to invest if you want a diverse nest egg to retire with. Here’s how things break down - starting with these assumptions:
Best Case Scenario:
You’re in your mid-20s now, and will be able to retire at 65
Your return is a consistent and optimistic 8% throughout all of your working years
You get a $4 coffee every single working day of the year
You never contribute outside of these morning coffees this one year
Now, I don’t know anyone who actually gets coffee every single day, and a consistent 8% is a lot to ask of an investment account. But, for a quick Excel experiment, these numbers will do.
You could spend over $1000 on coffee this year. Or, you could have $22,000 in your retirement account at age 65.
It seems like an easy choice, right? Who wouldn’t trade $1000 for $22,000?
With that said, these numbers are a bit dreamy for me. I definitely don’t spend that much on coffee, and the return is idealistic at best.
I wanted some assumptions that reflected a more likely situation:
I’ll probably retire at 70, not 65
Worst-case scenario, I’m looking at a 5% return each year
I’m only getting coffee once or twice a week, though I sometimes add a bakery item and I like the holiday drinks
I’ll give up coffee for a year, but not the rest of my life
I ran that situation here:
By giving up $500 now at age 25, I could have almost $4500 at retirement. That still seems like a pretty good deal to me. Realistically $500 isn’t a lot to cut over the course of a year. That’s also the kind of money you can hustle without too many extra hours.
In fact, that’s something I could see myself doing every year. This leads us to the next scenario:
What if you contribute $500 every single year, from age 25 to 70?
Repeated contributions are where things really start to take off.
The magic of compound interest means that the earlier you contribute, the more time your money spends working for you, and the more bang you get for your buck. Speaking of a single buck, let’s move away from using coffee as a unit of measurement. My point here isn’t that you should never drink Starbucks coffee again - far from it. What this really means is that every dollar invested matters, especially early on.
Here’s what the numbers say about a single dollar, invested 45 years before retirement:
It seems hard to believe, but every dollar invested at 25 will be worth somewhere between $9 and $32 at age 70. Is that crazy or what??
With annual contributions, the numbers look even crazier. The math gets wonky when you start using annual payments, but essentially, investing a dollar every single year - that’s just $45 over 45 years, in this example - yields at least triple the value at retirement age, and if you’re lucky, a whole lot more.
Okay, so by now, you’re probably convinced. Now, how do we put this to work in real life?
I want to make a clarifying remark from the start here - I’m not saying that you have to be miserable in your twenties so that you can retire. I also want to remind you that there’s a big difference between savings and investments; both are important, but they are not the same.
The answer to the question of putting this principle to work is simple - pay your future self first.
[The one caveat - if you really, truly cannot afford basic necessities like food or rent, don’t contribute to retirement until you can.]
If your employer gives you a 401k option, you can utilize that - especially if they have a match program. If you’re self employed or just wanting to find other options, there are lots of them! I’m no expert, but you can start by looking at Roth and Traditional IRAs.
Otherwise, find room to invest. I’ve used a retirement plan in this example, but there are lots of options. If you’re extremely risk-averse, you may want to try CDs, annuities, or bonds. If you’re young and have some time before you retire, consider exploring stocks, real estate investments, and any number of other opportunities.
Looking for some more ideas to get your retirement fund started?
If you want to work on your budget and find that $500 this year, try this post.
If you’d rather increase your income - start here with our favorite side hustles.
See you next time,
x Rin
