Perhaps the most common advice presented to people aspiring to achieve more financially is to skip their daily latte. The notion is that saving these few dollars per day, across a long period of time, will produce fabulous results. But the reality is that it's financial systems — not small spending changes — that will improve your finances.
There is nothing drastically wrong with this advice; lowering spending is often required to build wealth. You can’t save while overspending; overspending just builds a debt trap that ultimately has to be reckoned with. It’s an issue of opportunity cost; the small sacrifice today can have an outsized impact on a distant tomorrow.
Absent financial systems, however, the proverbial latte money will be absorbed into other spending with no gain. You get the pain without the gain, and that’s not how it is supposed to work. There’s not a ready place to put those five or seven dollars every day. So no one, well, almost no one, actually does that.
For most people, opportunity cost simply isn’t real. We weight the present need and discount the future need. After all, we have time. We are not wired to make those economic decisions. We are not economically rational beings. In many ways, that’s fortunate.
When the economic decision is at the point of latte purchase, it’s too late. We need better systems.
Saving for long-term goals needs to be systematized. This is the essence of the “pay yourself first” mantra.
Paying yourself first is to pay your future self first. You allocate what is necessary for your financial goals from your paycheck and you get to live on what’s left. That’s the “first” part — financial goals before anything else.
Theoretically this is great. Practically it has some challenges.
The single biggest problem is current overspending — but not on lattes.
The biggest overspending is on housing and transportation. If you live in a home that is a lot more expensive than what your income should allow, there is no amount of discretionary spending that you can eliminate to get on track.
The same thing with vehicles. Many people have too much vehicle for their budget. Not every suburbanite needs a $60,000 truck, but many have them. More people have them than can afford them. And those people are not adequately saving for the future.
For many people, making the switch to paying themselves first will take time. They need to adjust their major expenses to allow for the significant savings necessary to achieve long-term financial goals. Most people need to be saving between 10 and 20 percent of their gross income to achieve their goals, and that’s if they start while relatively young.
Those who delay will have a tougher climb in front of them. Waiting is likely to necessitate a poorer-than-desired retirement lifestyle. Too often there’s just not time or resources to play catch-up.
All funding for long-term goals should be systematized. Your money should come directly from your check and get dispersed into retirement accounts, education savings accounts, whatever is necessary for your own goals.
Systemized savings is painless. We don’t see the money and we don’t have to think of opportunity cost. We don’t need to consider the economics at all; we’ve already done that once.
Then you don’t have to think any more of opportunity cost.
Opportunity Cost vs. Alternative Cost
If all future savings is systematized and we are living within our means, then we don’t need to think of opportunity cost. Instead we get to think of alternative cost.
Let’s review “living within our means” so we’re all on the same page. If we are living within our means, we are funding our future goals and not using debt to fund our lifestyle. Our debt should be decreasing and our consumer debt should stay as zero.
An alternative cost decision is not the same as an opportunity cost decision. There’s no long-term delayed gratification involved. We are not giving up in the very real present for something in an abstract future. We are considering instead two or more things in the present for the use of our funds for our optimal pleasure. That’s a much better place to live.
Alternative use decisions for the latte are more like: Should I skip this latte and the next 10 lattes so I can get that new pair of shoes? Or perhaps: Should I skip this latte and the next 10 lattes so I can get that new putter or play at a course that’s more expensive than my normal course?
Or maybe it’s even as simple as thinking that skipping this week’s lattes means being able to go out to the movies this weekend. Or vice versa: Maybe skipping going to the movies means I get to have lattes all week.
Either way, an alternative use decision is a win. There is no abstract future many years from now where an older and more wrinkled version of myself will theoretically be happy. Either way I get to be happy now. In the present. I get to be happy in the present because I am taking care of the future systematically.
The Bottom Line on Financial Systems
It isn’t generally easy to get on track for our future financial goals. Many people need to take steps and increase their funding across time. This might mean signing up for a 401(k) plan initially at a low level to take advantage of all of the company match, and then increasing the funding each year until you get it where it needs to be.
Similarly, you might start funding other goals at a level below where you would like, but increase the funding annually to get on track.
If you’re not saving for your goals, skipping a latte isn’t going to make things ok. You need to take some bigger steps than that. Perhaps you should skip the lattes until you have everything systematized, give yourself some incentive that way.
Once you have all of your long-term goals on autopilot, you gain freedom to enjoy what’s left over. You still need to be responsible, but by living within your means and systematizing your long-term goals, you can make whatever decisions you want with the money that’s left over. Lattes or shoes? That’s a better kind of financial decision to have to make.