David Bach is perhaps best known for coining the term the latte factor, a phrase that has almost become a joke in personal finance circles. That’s too bad, really, because Bach has some good ideas. And the latte factor is a marvelous concept, applicable to many people who casually spend their future a few dollars at a time. Bach’s most popular book is The Automatic Millionaire. I’ve referred to it often, but never reviewed it until today.

The Automatic Millionaire is based on sound financial concepts. The author encourages readers to eliminate debt, to live frugally, and to pay themselves first. But the core of his book is unique: rather than develop will power and self-discipline, Bach says, why not bypass the human element altogether? Why not make your path to wealth automatic?

The latte factor
Bach argues that wealth is not a product of what we earn, but of what we spend.

Most people believe that the secret to getting rich is all about finding ways of increasing their income as quickly as possible. “If only I could make more money,” they declare, “I’d be rich.” How many times have you heard somebody say that? How many times have you said it yourself? Well, it simply isn’t true. Ask anyone who got a raise last year if their savings increased. In almost every case, the answer will be no. Why? Because more often than not, the more we make, the more we spend.

Bach has an excellent point. Remember how you used to live when you were in college? How much did you spend each month? How much do you make now? If you lived like a college student, what sort of monthly surplus would you have now? If you lived like this for five years, how much could you sock away? What if you lived like a college student for ten years?

Even if you choose not to reset your lifestyle to what it once was, Bach suggests that it’s important to examine your current expenses for subtle small drains. If you drink a latte a day, you’re probably spending about:

  • $3.50 a day
  • $105.00 a month
  • $1250.00 a year
  • $12,600 in ten years

Each person’s latte factor is different. For my wife, it’s actually lattes. For me, it’s comic books. Regardless, Bach says that if instead of spending money on our splurges we invested an equal amount, we could be well on your way to becoming millionaires. He’s doing nothing more than stressing the incredible power of compound returns.

In essence, a latte doesn’t just cost you $3.50. It costs you $3.50 plus the potential compound returns over the next 20 or 30 or 40 years. You’re not just spending pocket change — you’re spending your retirement.

If we can forego these indulgences and funnel the money toward savings, we’ll profit in the future. But the problem is — we like our 180-degree nonfat lattes. We’re not about to give them up. How do we bypass the human element?

Make it automatic
You’ve all heard that you’re supposed to “pay yourself first”. But what does this really mean? This concept simply states that before you pay your bills, before you pay your taxes, before you pay anything else, you set money aside for yourself. This isn’t money to spend, but money to save for the future.

“But how can I do this?” you might say. “I only make minimum wage.” It doesn’t matter. This principle says that no matter how much you earn, you must force yourself to set aside something for your future. If you don’t do it, nobody else will.

But, Bach says, human nature makes this difficult. Most of us think we don’t have enough to pay ourselves first. Whether we earn $8 per hour or $80 per hour, there’s always something to spend the money on. Bach writes:

In order for Pay Yourself First to be effective, the process has to be automatic. Whatever you decide to do with the money you’re paying yourself — whether you intend to park it in a retirement account, save it as a security blanket, invest it in a college fund, put it aside help you buy a house, or use it to pay down your mortgage or credit card debt — you need to have a system that doesn’t depend on following a budget or being disciplined.

The best way to do this is to make our savings automatic. For some people, this is easy. If your employer offers a retirement account such as a 401k, take advantage of it. Max it out. Contact your human resources department and request that a fixed percentage — 5%, 10%, 15% — be transferred from your paycheck to your retirement account. It’s best to do this now, but if you think you can’t possibly survive without the money, then wait until your next raise. Instead of taking the raise in your paycheck, have the increased income set aside in your retirement account. Continue to live on the amount you’ve been earning.

What if your employer doesn’t offer a 401k? What if you want to do this on your own? Open an Individual Retirement Account. (We covered IRAs in detail earlier this year.) “Whatever type of retirement account you open, arrange to have your contributions automatically transferred into it, either through payroll deduction at work or an automatic investment plan” run by a bank or brokerage firm.

Make it all automatic
If you can make saving for retirement automatic, why not do the same thing with your other financial obligations? The Automatic Millionaire features chapters on how to automate emergency fund savings, how to automate housing payments, how to automate debt payments, and how to automate tithing (or charity contributions). Bach’s basic tenet is this: by removing human nature, we can automatically do the right thing with our money. We can strive to become “automatic millionaires”.

(Much of Bach’s writing reminds me of my own pursuit of paperless personal finance.)

Conclusion
If you have your personal finances in order, you probably don’t need to read The Automatic Millionaire. But if you’re struggling to gain control, this book can make a big difference. I read it in the winter of 2005-2006, as I was beginning to take control of my money. I learned a lot.

I’m not sure that it’s important to own The Automatic Millionaire — once you’ve read the book, you get it — but I think many people can learn a lot from what Bach has to say. This book is ubiquitous. You probably know a money-savvy friend from which you can borrow a copy. I guarantee that your local public library has it. If you’ve been struggling to set up a retirement plan, I encourage you to read The Automatic Millionaire. It just might change your life.

October 21st-27th is National Save for Retirement Week in the United States.

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