Frugal Living, Personal Finance 

When A $945 Espresso Machine Makes Sense

Espresso ShotsTim Clark, author of The Prosperous Peasant (my review), has a blog called Soul Shelter and he posted a guest article last week where the author’s friend Dave, a multi-millionaire from the dot-com boom, bought an espresso machine for $945. At first I reacted the same way as the author, “It must be nice to be able to afford a high-end, fully automatic espresso maker, I mused aloud.” But as the article continued, I saw the logic.

“OK, consider this: One double latte costs three dollars at a coffee shop, so your outside coffee-drinking habit comes to six dollars a day for you and your wife. That’s $2,190 per year in after-tax dollars,” Dave extrapolated. “Assuming you’re in the 27 percent tax bracket, that means you have to earn $3,000 before taxes to pay for those lattes. That’s more than a month’s wages for a substitute teacher here in the state of Oregon.”

I don’t spend $3 at a coffee shop each day but he and his wife do. I don’t spend $2,190 per year in after tax dollars on double latte’s, but he and his wife do. I don’t have to $3,000 before taxes to pay for coffee each day, but he and his wife do. For him, the $945 espresso machine makes perfect sense even after you factor in the cost of milk, beans, etc. It may not make sense for me, but for him it makes perfect sense.

This is basically the reverse of the monthly payment math trick. The monthly payment math trick is where a salesperson tricks you into paying more for something by justifying it in terms of monthly payments. If I were to argue that he’s making a bad decision, I’d be falling for the trick in reverse by focusing on the $3 a cup cost versus the $1000 espresso machine. When you do the math and find total cost, his logic is sound. You could argue that he shouldn’t be spending $3 on a double latte every day but then you’re not talking money anymore, you’re getting into personal preferences.

The bottom line is that you should always be doing the math. A commenter, Hank, said that his mantra this year is to “just do the math.” When you do the math, the answer is usually pretty clear. In this case it’s crystal clear, once you get past the $945 up-front cost. The other comments for this post are pretty good too, I think many of the commenters know each other so it makes for some lively debate.

What are your thoughts on the purchase?

(Photo: asurroca)

 Personal Finance 

$325 Cups of Coffee, or, Why The Latte Factor Matters

The Latte Factor was a term coined by David Bach to represent the idea that the key to reaching financial prosperity is to cut out the little things in life that you’re paying other people for, in this case coffee, and spend that money on yourself and your future. Mathematically, it involves taking the $5 cup of coffee each day, or whatever other discretionary spending you’d like to substitute in its place, and calculating how much that $5 would be worth in forty years if you were to have invested it. It’s not a particularly novel idea because everyone can appreciate that saving $5 each day and then compounding that at 11% each year for forty years will result in a huge number. But it’s value is in that it challenges you to examine the motivations behind your spending and how you could change those for the better.

It’s been shown that if you reduce the price of something from $9 to $8, people feel as though they’ve saved more money in that discount than if the original price were $8 and were dropped it to $7. The larger numbers seem to trick the consumer’s unconscious into believing more money is saved even though it’s not, percentage-wise. It’s also been shown that when people spend on credit, they’re able to enjoy the pleasure of the purchase without experiencing the pain of actually paying for the purchase, thus continuing to fuel our instant gratification mentality.

Now let us mix and match the two ideas into a super beast that many companies have come to love and take advantage of – large capital purchases on credit. When you make a large capital purchase, such as a house, or a car, or even a plasma television – you spend quite a bit of time researching in order to get the best deal. You do that because you can potentially save more because you’re spending more. You’re aware of the spending because of how much one single item is, thousands, and because of how you’ll be paying, almost immediately. (By “paying” I mean that your lifestyle will be immediately affected by this purchase, you will have to spend less in some places to service the purchase, even if you don’t pay off the entire balance immediately).

Now, what does this have to do with a $300 cup of coffee? It’s a mere five bucks, five bucks won’t bust your budget, and five bucks will hardly register on the radar for those who drink it every single day. It’s not a plasma television, it’s not a car, and it’s certainly not a house… it’s a drink that will perk you up, make you feel awake in the morning, and gosh darn it, you deserve it. However, that $5 purchase is a capital purchase when you extrapolate it over forty years.

If you compounded $5 over 40 years at 11%, that cup of coffee costs will you $325 minus taxes. Three hundred bucks for your cup of coffee. A $300 a day coffee habit would probably qualify you for Coffeeaholics Anonymous. Even if you compounded it at 8%, that cup still costs you over a hundred bucks. See, you care about the plasma television purchase price because it’s a thousand dollars now and you don’t care about the cup of coffee because it’s a mere $5 now; but won’t you plus forty years be wishing you didn’t have that cup of coffee? I would think that you in forty years deserves an extra $300 a day just for putting up with you for the last forty years, don’t you? (wrap your head around that little Philip K. Dick mess of confusion)

I think so.

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