Coffee and Cigarettes [part 1]
There are a lot of money and finance blogs/articles out there. A lot of Suze Orman wannabes, even though Suze Orman has it wrong in the first place. Their concept is pretty much the same, and it’s been regurgitated all over the web. Here, I’ll sum it up for you right here son.
- Find out where you are spending money
- Find ways to curb your spending so you can start saving money
- Pay off your bad debts starting with highest interest rates first
- After your debts are paid off, save three months of salary in a safe, non-risky account
- Start saving for retirement
Here is an post with an idea for step#2.
The gist of the article is that by cutting down or eliminating small unnecessary expenses like expensive coffee and cigarettes, you can save a little every day which will add up to a lot for retirement. Again, this is standard regurgitated advice found all over the place. It’s like a near-hospitalized drunk puking numerous times on his way home; he’s left his mark in numerous places and the stench is just everywhere. Gross.
The average fancy cup of coffee…can cost you up to $5 per cup…You can do the math…a $5 coffee every morning on your way to work will cost you…$1,200 per year. $1,200 invested at 8% ever year over the course of your working life can equate into over $365,000 in lost savings and investments.
Immediately, it’s already wrong. The assumptions made are all wrong…well, oversimplified at best.
- Doesn’t say it in the article but the calculations were made assuming your investing horizon (“working life”) is 42 years
- Coffee costs $5. Not for everyone, but OK fine. One thing that is missing is that coffee in the future doesn’t cost $5. We need to factor in inflation. Which means that you are saving more and more every year.
- Invest and get 8% return. 8% assumes that you fully invest this money in the stock market. Generally (unless you are insane) you move your assets into safer investments as you get older. So being a young risk taker now you can expect 8%, but expecting 8% when you’ve got gold-digger hoez hanging by your side just waiting for you to pass so they can get their hands on that nice chunk of 365k coffee money you’ve saved up so that they can get themselves a new rack and a benz, this 8% assumption might not be so realistic. It’d be wise to start moving your money into safer investments like government bonds, and I mean like most of it bro.
- Assumes no variance. Standard deviation of the US stock market is around 20%. This means that in any given year you will probably get anywhere between -32% to 48% return but it should average out to 8% given enough time. But, this variance matters, and it matters a LOT, a LOT squared. I’m too lazy to explain. Just bring up 42 year charts of the SP500 for different time periods and think about it dude.
- $365,000 42 years from now isn’t worth what it is today. Assuming a constant 3% inflation, it’s actually worth about $105,000 in today’s dollar terms.
I did my own analysis using
- 3% inflation meaning you save even more with every passing year
- Making 8% returns in year#1 but decreasing the expected return by 0.1% every year to account for a normal person becoming more conservative with age
So what ends up happening? Well, you end up with around $280,000. Oh wait, in today’s dollars that is $83,000. Oh wait, I also forgot to mention taxes that you need to pay when you start withdrawing this money. But, that’s only like what, 20% or more? Oh, also, if you were actually actively managing your investments (like selling the stocks you bought when you were younger to make your portfolio less aggressive) you’ve paid taxes on your gains earlier and so the amount you actually had invested earlier was less than this estimate thereby reducing your final return even more. Oh, one more thing, the commission, the slippage, the market variance, that time you sold some investments for the downpayment on your first house and then that one weekend in Vegas. At least all those gold-diggers won’t get that benz now. Wait, what gold diggers? You’re poor! Hahaha…you loser you.
I’m just trying to illustrate that the original analysis is way over simplified. Heck, even my analysis is over simplified. Make no mistake, the world is a complex place, a lot more than these dunces with their saving for retirement tips think. And I’m not even done ripping up this article yet. More to come in my next post.
Coffee And Cigs [Part 1]
Coffee And Cigs [Part 2]
Coffee And Cigs [Part 3]
April 7th, 2010 at 9:16 pm
You’re right- your analysis is just as oversimplified as the original. I’m nowhere near the 20% tax bracket, and if I plunk my savings into a Roth IRA then I won’t pay taxes on the withdrawals. I ought to be able to live pretty nicely for 2-3 years on $83K, considering my current standard of living. Seems like a good reason to quit Starbucks to me, except that I don’t go there.
I don’t think the original advice is a one-size-fits-all kind of thing. People are in all different kinds of financial states. And I agree that the numbers they give are less than realistic. But the idea of really looking at where your money goes is a good one. So many people mindlessly swipe the card without considering what that purchase really is costing- if you don’t pay off the credit card each month, then that $5 latte costs more than $5. We nickel and dime ourselves with these “little” purchases that do add up. I’d say $1200 a year is nothing to sneeze at. It’ll pay for your car that breaks down, or the new hot water heater that you’d otherwise put on the credit card. It’s all a matter of getting out of the “I deserve it” mentality and onto the road to financial health.