A Mini-Lesson In Compound Interest: What If You Gave Up That Latte/Soda/Daily Small Purchase And Invested It?
What is known as the “latte factor” in personal finance goes something like this…if you skipped that latte and invested it you would have $2 million dollars in 30 years. Commentator Helaine Olen highlights a few shortcomings in the assumptions made to come up with this estimate.
Your students are going to come up with their own “[insert drink here] factor” to see how much forgoing that drink will save them in the long run. Here are the steps:
- Identify the cost of a daily expense that you have everyday that you could forego without much pain (lunch doesn’t count!). If they don’t have one, have them use $5 as a proxy for the cost of a latte.
- Go to this investment calculator. For assumptions, try these:
- Years: 30
- Rate of return: Pick a number between 7-9%, which seems a reasonable return if you were invested in a S&P500 index fund.
- Initial investment: $0
- Annual investment: Take the cost of the daily expense item and multiply by 360. So, a $5 latte would translate into a $1,800 annual investment
- Expected inflation rate: 3% seems reasonable
- Tax Rate: Assume that money is saved in tax-deferred retirement account and set at 0
- Inflation adjustment: check the box as the price of your daily item is likely to rise at cost of inflation.
- Show values after inflation: check the box so that the TOTALS will be in today’s dollars. Students can toggle this on and off to see how dramatically inflation impacts their totals.
In case you were wondering, that $5 latte invested over 30 years at 7% per year amounts to a little over $122,000 in today’s dollars. Not exactly that $2 million headline that was touted as the “latte factor” but still a lot of money!
About the Author
Tim's saving habits started at seven when a neighbor with a broken hip gave him a dog walking job. Her recovery, which took almost a year, resulted in Tim getting to know the bank tellers quite well (and accumulating a savings account balance of over $300!). His recent entrepreneurial adventures have included driving a shredding truck, analyzing executive compensation packages for Fortune 500 companies and helping families make better college financing decisions. After volunteering in 2010 to create and teach a personal finance program at Eastside College Prep in East Palo Alto, Tim saw firsthand the impact of an engaging and activity-based curriculum, which inspired him to start a new non-profit, Next Gen Personal Finance.