An article I wrote several years ago …
A Starbucks A Day Pushes Retirement Away
Investing is the glamorous side of personal finance. To be a wise investor, however, it is first necessary to develop and commit to a sensible savings plan – a less glamorous endeavor. Saving is difficult because resources are limited, while opportunities to expend them are unlimited. Nonetheless, even modest frugality today is the parent of tomorrow’s liberty.
Introduction
Cannot people realize how large an income is thrift? ~Cicero
From time to time it is a useful exercise to revisit the age old proverbs which were taught to us as children, but have faded from consciousness with the passage of time. Who among us cannot complete the phrase, “a penny saved is …”? Yet who among us pays frequent attention to its message? That the virtue of thriftiness is espoused in sources as disparate as the Boy Scout Law and Shakespeare’s Hamlet, and by American Presidents such as Calvin Coolidge as well as legendary entrepreneurs such as Thomas Edison and John Rockefeller does not render the concept a quaint relic. Rather, it is the mountains of media directing customers to myriad “get rich” investing strategies that have lured Americans into complacently believing that the way to build personal wealth is to find the appropriate investing tool.
Fortunes rarely fall from the sky or spout up from the ground. Just as in any goods market where without supply there can be no demand, there can be no investing without a source of funds to invest. And while a some people may receive sizable bequests or win lotteries, for the vast majority, wealth will come from accumulated savings over the course of their working lives.
It Only Takes a Little
Saving, by definition, entails personal sacrifice – it requires that consumers spend less than they earn. The term sacrifice connotes something far darker than it should in this sense. When individuals save, their foregone consumption is not lost forever; instead it will be recovered many times over in the form of increased future consumption. A surprisingly small sacrifice is required to generate substantial rewards.
How small? About 24 ounces! Take, for example, American coffee consumption. Over 170 million Americans drink coffee, each consuming over three cups of coffee per day. Two “tall” sized (12 ounces each) halfcaf soy almond lattes at a nearby Starbucks cost about $6.00; 24 ounces of coffee from the nearby general store runs about $2.25; home brewing costs somewhat less. For the sake of simplicity, assume that spending approximately three dollars per day on coffee is within reach of virtually every American.
Suppose that Scott is age 22 and starting his first job out of college. Each day he passes a Starbucks and must decide whether he will stop in and spend $3.00 on a Triple Grande Breve Latte, or pass by and drink the “free” coffee in his office or at home.
If Scott chooses to forego the Starbucks, he might invest the $3.00 into a mutual fund each day, or a total of $1,095 per year. A mutual fund representing a broad range of US stocks would expect to earn approximately seven percent per year in real terms (i.e. adjusted for inflation), which is the real rate of return of the S&P 500 since 1926.
When Scott saves money, say $1,000 per year, and it is paid interest of seven percent per year, he earns $70 in the first year. However, at the end of year two, Scott will earn interest not only on the initial $1,000, but also on the $70, for a total of $74.90 in interest rather than just $70. This is the power of compound interest. Each year Scott earns interest not only on the money he saves, but also on the interest accumulated after each year.
The effects of compounding are small in the early years. In the above example Scott earns an additional $4.90 in year two, but the gradually increasing impact of compound interest sets the stage for spectacular growth later on. In this example, after year ten, the extra interest earned on the accumulated interest amounts to $267.10. By year 20 this amount increases over fivefold to $1,470 and after 50 years this amount reaches an astounding $24,957. And these are the earnings from saving only in the first year.
Returning to the specific example from above, table one illustrates how much money Scott will accumulate by saving $3.00 per day over various time periods and at different real rates of return. The last column in the table shows how much money Scott actually invested as a result of consuming $3.00 less of goods and services each day. As the table shows, if Scott saves every day for the first ten years of his working life, he will have accumulated $15,856 if he is able to earn seven percent on his account.
Table One: Accumulated Earnings from Saving $3.00 per Day

Rate of Return 



### 
3.0% 
5.0% 
7.0% 
10.0% 
Amount Invested 
Years 
5 
$5,907 
$6,220 
$6,555 
$7,102 
$5,475 
10 
$12,769 
$14,206 
$15,856 
$18,811 
$10,950 

15 
$20,742 
$24,460 
$29,054 
$38,114 
$16,425 

20 
$30,006 
$37,626 
$47,784 
$69,938 
$21,900 

25 
$40,768 
$54,532 
$74,360 
$122,403 
$27,375 

30 
$53,272 
$76,239 
$112,074 
$208,896 
$32,850 

35 
$67,800 
$104,111 
$165,589 
$351,490 
$38,325 

40 
$84,678 
$139,898 
$241,529 
$586,572 
$43,800 

45 
$104,288 
$185,849 
$349,290 
$974,130 
$49,275 

50 
$127,072 
$244,851 
$502,204 
$1,613,062 
$54,750 
As illustrated earlier, this just scratches the surface of the power of his savings. By age 42, Scott would have accumulated $47,784 from savings of $21,900; from whence the power of compound interest really takes off. After 45 years of working, he can retire at age 67 with $349,290 in the bank while he would have directly contributed less than $50,000 to fund his account. And these figures represent today’s purchasing power, since they are all calculated in real terms.
Putting the Power of Compound Interest to Work Early
What if our young worker “waits until he has more money” before embarking on a savings plan, and begins saving after 10 years of work at age 32. At the outset, it might not be obvious to Scott how much wealth is acquired by saving early. After all, he would be giving up just under $1,100 per year in savings by delaying. However, the foregone interest on these early savings adds up to a considerable sum.
Instead of having nearly $350,000 at retirement, he will now only have $165,589 at age 67. By delaying his savings by only 22 percent (roughly $11,000 over 10 years), it will cost Scott over half his retirement savings. In order to retire at age 67 with $349,290, and beginning to save at age 32, Scott would have to more than double his daily savings, from $3.00 per day to $6.33 per day to make up for the lost time. If he doesn’t begin his plan until age 42, his daily savings would need to nearly quintuple to $14.09, and by leaving only 25 years to retirement, he would expose his retirement portfolio to substantially more risk than over the original 45 year horizon.
On the other hand, if Scott does begin saving at age 22, and chooses to delay retirement by just one year he will accumulate an additional $26,458 and if he can manage to work until age 70, he will earn an additional $85,268. Compare these amounts to what Scott earns after his first one and three years of saving. After one year of saving, he will earn only $1,134 and after three years only $3,655. There is an enormous payoff to beginning a savings program early; it is simple to turn a small amount of money today into a substantial amount later on.
Considerations
Four points are worth emphasizing. First, the foregoing example overlooks the tax advantages that governments have conferred upon various types of savings. Depending on which vehicle you choose to place your savings (e.g. 401(k), IRA, etc.) you will be able to save money on a pretax basis. If, for example, Scott’s combined state and federal marginal income tax rate is 25 percent, then each $3.00 he saves will reduce expendable income by only $2.25. While tax payments will be due on future accumulated savings, it is likely to be less costly to incur those expenses in the future.
Second, coffee isn’t germane to the above discussion. The important point is that a powerful savings program is well within the reach of almost all Americans – we could just as well use your monthly cable bill as an example. In either case, we are not advocating austerity measures. An alternate way to think about table one is that it shows how much (at minimum) you value drinking a cup of coffee per day. The table could just as easily be labeled, “What is the smallest amount I would be willing to accept to forego coffee drinking for the designated time period?”
Third, thrift is not to be judged solely by the test of saving or spending. Consumption is not intrinsically imprudent. There are periods in life when it is prudent to spend more than you earn, such as when you are investing in your education. Furthermore, it is not wise to “save at all cost.” Foregoing treatment of a tooth abscess would clearly be foolhardy if the sole purpose for doing so was to save a little more money.
Finally, it may be entirely rational to forego saving even a small amount today. For those individuals who can reasonably expect large increases in future income and future retirement contributions, smoothing consumption over the course of a lifetime may maximize individual satisfaction. We would caution however that many individuals adjust their “needs” up as their income increases and that if you do not have the willpower to save more now, you are unlikely to gain that willpower later.
Conclusion
It is quite simple to suggest that without any significant lifestyle change, all Americans have the ability to build substantial wealth by starting a disciplined and early savings program. Just because something is simple does not mean it is easy.
Perhaps the biggest distraction for individuals is the belief that they cannot save if they have debt. Repayment of debt is equivalent to savings. Reducing the amount you owe on a credit card by $1,000 is the same as increasing savings by $1,000. And just as you try to invest in assets with the highest returns, you should pay down your debts carrying the highest interest rates, in descending order. For example, if you have an outstanding balance on a credit card costing 12 percent and a car loan costing six percent, the credit card should be paid off first, then the car loan. Doing so is equivalent to investing in two riskfree assets, one returning 12 percent and the second returning six percent.
Putting away $3.00 a day for 45 years at seven percent is no guarantee that you will have $350,000 in the bank at retirement. What it does guarantee is that your net worth will be $350,000 higher than it would have been absent the savings plan. Thus, if you live a spendthrift lifestyle amidst your savings plan, you will be $350,000 less in the hole than otherwise. In either case, the dramatic increase in your net worth can be accomplished by foregoing only a small fraction of that amount of present consumption. There is nothing trite about highlighting that virtue.
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