The $5-latte problem and a radically conservative solution

The $5-latte problem and a radically conservative solution

I call this the latte problem, where two competing philosophies of personal finance are expressed in a single cup of coffee and milk.

You've heard it before. Save S$5 on that latte every morning and start on the path to financial independence! Because, you know, S$5 times 365 days is S$1,825 of savings a year, compounded over 50 years at 4 per cent to become S$280,000 that you could have had if you just stopped downing that perk-me-up coffee.

The trivial things we spend on in life can add up and steer us away from our financial goals, goes the argument.

If you want to use a pejorative term, you can call this the penny-pinching path to financial freedom. I call it the survival method. This is the way our parents or grandparents lived through war and poverty, living simply and watching the purse-strings carefully.

The competing philosophy to get rich eschews all this talk about having to save on your latte. It can be summed up in the proverb "penny wise, pound foolish".

The idea - for the young at least - is that by focusing too much on whether we should have a coffee or not, we lose sight of the big picture.

This view is expounded by San Francisco-based entrepreneur Ethan Bloch, who advised his fellow millennials in a Bloomberg article to "just have your f****** latte!"

"Just having that conversation in your head and using self-control over US$3 is time and energy misspent," he said.

Another objection to saving money this way is that we should just not be so hard on ourselves.

This view is pithily summed up in the title of a 2011 Wall Street Journal column: "A dollar here, a dollar there. But so what?"

"To my mind, a few out-of-budget small purchases aren't going to break us. And they might actually benefit us, giving that little lift that can come from a quiet moment of self-appreciation," wrote Katherine Rosman.

A war of ideas

Speak of personal finance, and you might picture mundane but practical advice on budgeting, saving, insurance, investing, credit cards, home buying, careers, retirement, healthy living and so on.

If you surf around the Internet or browse the business sections of the bookstore or the library, you'll see similar ideas espoused by a large community of writers.

But all this sedate and sensible advice over planning our finances and our lives belies a raging debate over two ways of living and getting rich.

On one side is what I call the old-fashioned method.

This way depends on you holding a steady job, no matter how humble, and diligently storing some money away for a rainy day every year. You live below your means, spend less than you earn, and invest on the side, preferably dollar-cost averaging into an index tracking exchange-traded fund. It's that simple, people tell you.

On the other side are those encouraging entrepreneurship. You are all mindless work-drones wasting away in the office and doomed to a life of mediocrity, goes the spiel. This is a new economy where fortunes can be made on the Internet through marketing goods and services, for example. Dare to take the first step and you have a chance to be truly rich. Discover yourself!

This debate touches on debt.

The old-fashioned attitude is that debt is bad. One should pay off debt as quickly as possible, and strive to have as little as possible. This includes buying a cheap house or even better still, avoid a home purchase altogether.

One of the best posts summarising this attitude towards debt comes from personal finance blogger Mr Money Moustache, in a post titled: "News Flash: Your Debt is an Emergency!!"

He had harsh, yet funny words for those who loaded themselves with consumer debt.

"If you borrow even one dollar for anything other than your primary house or a profitable investment, the very next dollar you can get your hands on should go to paying that back," he said.

"You don't space it out all nice and casual with 'monthly payments', and you don't have a 'budget', 'entertainment allowance', or any other such nonsense. You don't start a family or get yourself a dog, and you don't go out for drinks and dinner with your friends. There will be plenty of time for these things later."

"The correct response to this sort of debt is, 'AAAAUUUUUGGGHHHH!!!! THERE IS A CLOUD OF KILLER BEES COVERING EVERY SQUARE INCH OF MY BODY AND STINGING ME CONSTANTLY!!!! I NEED TO STOP IT BEFORE I AM KILLED!!!'"

While consumer debt is treated as bad, borrowing for a house or for an investment is in a greyer area.

Robert Kiyosaki of "Rich Dad, Poor Dad" fame noted there is good debt and bad debt. Good debt is used for loans for property or to buy equipment for a business, he said.

"The rich carry debt. They generally carry a lot of debt. But they have assets that more than make up for the debt they carry. In fact, the rich not only carry debt, they also use it to get richer," he said on his website.

Similarly, Mr Bloch, the tech entrepreneur, advises the young not to worry about their student loans too much.

"Even if you have a ton of student loans, I'd still say figure out what you want to do even before you think about paying them back," he said.

"If you're 21, 22, spending the next few years deciding what you want to do will be more important long-term than making payments for three years."

The problem with staying conservative

Who is right? Who is more likely to end up rich: the stodgy conservative worker or the entrepreneurial, risk-taking businessman?

I don't think there is one correct path. We should have a bit of both. But I know which path is easier.

First, I would reframe the definition of rich. Of course being rich is more than having money, but possessing health and social capital, with meaningful relationships with not only the people important to you but the larger community you live in.

But because money plays such a big role in our lives, we need to have a monetary definition.

My definition still depends on a number of variables, but it is a place to start. I define being rich as being currently able to pay for the stream of expenses you are reasonably likely to incur for the rest of your life, from the net assets you saved up, and the passive income those assets generate.

If you are thus rich, you are financially independent, in the sense that you can stop making money for long periods of time and still turn out to be all right.

To me, any plan to getting rich in this manner needs to have a high chance of succeeding.

And this is where I lean towards the old-fashioned, conservative method. I do not think starting a business is the way to go for most people, who have no idea how difficult it is to start and run a sustainable business, handle all the responsibilities required, while dodging the numerous traps along the way.

Borrowing large amounts of money to invest, as Mr Kiyosaki espouses, is too high risk a strategy. Fail, and you will lose everything you have, even harming your loved ones in the process.

You might think you are young and have all the time in the world to find yourself, your passion in life, and your ideal vocation.

Yet you can also find yourself in your 30s with a string of failed startups and plenty of debt to your name. You might yet go on and succeed, but few people can make the sacrifices required - not if they have a family to take care of.

Yet the old-fashioned method of saving can be too slow, and risks being insufficient.

Let's run through a typical plan, which is to save S$500 a month from age 26 and invest the entirety in a portfolio that yields 4 per cent a year, reinvesting gains every year.

If you keep this up all the way until you're 60, you'll have some S$440,000 should you choose to retire. This will essentially give you a monthly income of S$1,400 for as long as you live.

But remember that a sum of money when you're 60 is worth less. Factor in 2 per cent inflation a year, and you will find that your spending power then will be roughly half of what you have now, 34 years later.

Essentially, this means you have S$700 a month to spend. You will run out of the money when you are around 94 years old.

Whether that sum is enough for you to retire on is debatable. But this is not the point of this exercise.

A radical conservatism

That first savings plan required you to put aside S$500 a month for 34 long years. Can you be assured of employment for the entirety of those years?

You might be if you are in a vocation like medicine. If you are a doctor, your skills are unlikely, for now, to be rendered obsolete by a machine.

Not many of us can say that with certainty. And even if you are assured of very long term employment, you might be young and impatient.

What if there was a way for you, such that you can stop work after just five years, and achieve a higher level of income than the person in the first S$500-a-month savings scenario?

At age 25, instead of thinking of saving just S$500 a month like everyone else, you can go all out.

You draw on all the resources of youth and time to accumulate as big a stash as you can while you're young, such that you hit a six-digit sum in your 30s and use the power of compounding to do the rest.

In the meantime, you live in a simple and self-sufficient manner, spending money as efficiently as possible. This way of living is not about extreme miserliness, but more about reorienting yourself with what is meaningful in life that happens to be free or costs little.

The philosophy behind this idea is known in Internet circles as FIRE, or financial independence and retiring early. It is a radical twist on the conservative idea of working and saving.

The numbers are easy to work out.

In our first example, we assume savings of S$500 a month. This is likely not difficult to do on a S$3,000 a month fresh graduate salary. Saving S$500 implies a savings rate of 17 per cent.

In fact, according to a crowdsourcing app created by the Central Provident Fund (CPF) called CPF starter, the typical person aged under 35 who had downloaded the app was saving S$800 a month, with half saving more and half saving less.

What if a fresh graduate can ratchet his savings up as high as possible, to say S$2,500 a month, or a savings rate of 83 per cent? This will mean S$30,000 a year. Keep it up for five years, and you will get S$150,000 to invest by the time you're 30.

Where will that take you?

As it turns out, you will actually end up with over S$480,000 at age 60, more than the S$440,000 we got in our first example.

This means that once you have S$150,000 saved at the end of your 30th year, you don't need to put in a single cent for the next 30 years to achieve a superior result to the poor slogger who diligently saved S$500 a month for 34 years.

Why is this the case?

This is a demonstration of how it takes money to make money. Your S$150,000 can compound at a far faster rate than saving a small sum for decades can ever get you.

Our little example illustrates a simple truth: the more you have at the start, the better off you will be for life.

And you just need five years. You don't even need to start at age 25.

New thinking

The tricky part is how a young person can save S$150,000 in five years.

A bit of radical thinking is needed. What's stopping people from pursuing this path can be a lack of understanding of basic ideas of personal finance.

To get rich, people have two levers to operate: you either pull the one labelled "get a higher income", or you work the one called "cut your expenses".

Some people prefer to exert their entire weight on the first. They like to climb the corporate ladder. They will become partners of law firms, senior managers in their corporations, or highly successful entrepreneurs.

If you don't think you are that kind of ultra-ambitious person, what you can do instead is to work on the second lever to cut your expenses as much as you can.

In the meantime, try to do your job the best you can such that you can get promoted to earn a higher salary. This is a far less risky way to make money, than quitting your job to pursue a startup idea, or convincing a banker to help you with your business plan.

Our circumstances all vary. To save S$2,500 a month on a S$3,000 salary, for example, means you are spending just S$500.

To spend just S$500 a month, you will have to take public transport, avoid restaurants, eat homecooked (and possibly healthier and more nutritious) food, and stay with your parents. You will also need good health, a supportive partner, and a willingness to go against the grain.

And rather than saying it's not possible because of this and that, you need to think of how it can be possible. The change in mindset tends to come from realising that lower expenses does not necessarily lead to a lower quality of life.

Other examples

If you do achieve a measure of financial independence by just hardcore saving on an ordinary job, you are not alone. Some have done this and shared their experience. They achieved significant financial milestones in just five to 10 years. Looking at their stories, it is never too late to start doing something similar.

One of the most well-known proponents of the philosophy of FIRE and hardcore saving is physicist Jacob Lund Fisker, who blogs on his site, called Early Retirement Extreme. He started saving intensely at age 25 and declared himself financially independent at age 30, getting married in the same year.

He had an amount saved up that was far from a million dollars and was making less than six figures annually. But he had the confidence to retire because he was only spending US$5,000-US$7,000 a year.

Today, he is age 38. And as he notes on his blog, he has 91 years of annual expenses saved up.

The other blogger mentioned in this column, Mr Money Moustache, is a Colorado software engineer named Pete who semi-retired at age 30, not that long since he started working at age 22. Together with his wife, the couple accumulated US$800,000 in nine years by spending moderately while investing in index funds and property.

Both then quit full-time work around 2006 to look after their child. The family spent US$25,000 in 2014 - which he admits includes US$9,000 of unnecessary spending, including US$5,000 on travelling.

Back home in Singapore, a number of examples come to mind. One is Christopher Ng Wai Chung, who was interviewed by The Sunday Times in 2009. At age 34, he was earning S$24,000 a year from his investments that covered his expenses. The former IT manager saw his investment income exceed his take-home pay at age 39. Today, aged 41, he is studying law.

Another young man, blogger JW at wealthbuch.blogspot.sg, graduated from university in 2008, accumulated his first S$100,000 by end-2009 through savings, giving tuition and investing, and recently noted that he has more than S$300,000 in savings at age 32.

Yet another recent example is Canadian pension analyst Sean Cooper, who at age 30 finished paying off the mortgage on his C$425,000 (S$438,000) three-bedroom bungalow in Toronto.

He worked in several jobs while in school, saved a downpayment within three years of graduating, stayed with his parents, cycled to work, and packed his lunch. After he bought his house, he continued working part time as a financial blogger, lived in the basement and rented out the rooms upstairs, while maximising the prepayments allowed on his mortgage.

He was making just C$55,000 from his full-time job a year, but made around C$40,000 a year in freelance income. He spent C$800 a month in discretionary expenses.

He paid off his mortgage in three years.

This brings us back to that latte. Cutting out the latte is a metaphor, really, for thinking in a different way and changing a habit to achieve a goal.

The bad news is if you want to follow the path of Messrs JW, Christopher, Jake, Pete and Sean, you probably have to give that latte up.

The good news is, after five years, you will probably be able to drink all the latte you want.

Actually, you might be so used to not drinking latte that you will have no desire to touch a latte again for the rest of your life.

Here's to some radical thinking in 2016. Have a latte with that. Or maybe not.


This article was first published on January 4, 2016.
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