Reducing Big Expenses vs Small Expenses
A recurring theme across personal finance articles is the same advice regurgitated over and over: stop buying coffee every day, cut your cable, stop going out to eat so much, yada yada yada. We all know this by know, it’s nothing new. While not everyone tracks their expenses or knows exactly how much they’re spending, most people have a general sense about where they could improve.
The biggest issue with this traditional advice is that it harps on a few purchases as being the root problem. This a simplistic way of looking at it. For example, for people who love coffee, the thought of cutting it out of their budget sounds horrible. Instead they continue spending how they’ve always spent.
This concept of cutting down on small expenses is also called the “Latte Factor,” a term made popular in the book The Automatic Millionaire by David Bach. A key aspect of his book was to cut down on small expenses, automate those savings into investment accounts, and over time those investments would grow to the point of making you a millionaire.
I’m a fan of the book, and a few lessons from it were integral in getting me started on my own personal finance journey: the concept of automation (savings/investing/bills), “paying yourself first” (saving a portion of each paycheck before any spending), and focusing on cutting down small expenses.
Is the Latte Factor true?
This is a huge debate in the personal finance community, but here’s my take on it. The Latte Factor is often overblown, BUT small expenses do add up. The problem isn’t the coffee, the problem is the mindset. Too many people spend money on mindless purchases, either on impulse or out of routine. If you’re buying a coffee every day because it’s what you’ve always done, or going out to eat for lunch every day, those are areas you should look to cut back on. Mindless habitual spending doesn’t bring true joy, it results in wasted money.
Daily habits can help create or destroy your financial future. If your daily coffee is something you look forward to each day and is the highlight of your morning, by all means keep it in your budget and cut back on something else less meaningful to you. For us, eating out and cable have been easy to cut, but we always leave room in our budget for travel. For people who have their finances in order, the Latte Factor starts to become a needless guilt trip for small indulgences.
Awhile back one of my favorite blogs, The Simple Dollar, published a post talking about whether it was better to focus on reducing one or two large expenses, or multiple small expenses.
Large Expenses: “The Big 3”
The 3 biggest expenses in most people’s budget are housing, transportation, and food.
Here’s a quick look at each of these three categories in our budget:
Rent – We live in the Bay Area, which has an extremely high cost of living. We try to minimize this expense by living in a one bedroom apartment and researching the surrounding cities/neighborhoods to make sure we were getting the best value for our money. The only way we could cut this down would be to move somewhere else or live with roommates. Moving somewhere else would likely involve a much longer commute.
Transportation – We have two vehicles, and we limit expenses in this category by planning to drive these same two cars for quite some time. We also research car insurance rates and have switched plans to obtain a lower rate. Our commutes are both short which leads to less money spent on gas and less wear and tear on our cars. We could cut back in this category by going down to one car (logistically would be extremely difficult as we work in opposite directions).
Food – This is an area I think we do well in and would be extremely difficult to cut down more than we already have. We very rarely eat out, and cook the vast majority of our meals at home. We buy some of our food in bulk.
I’m planning to do a mini series of posts that takes a deeper dive in how we handle this category including: how we cut back on eating out, key grocery items we buy, our meal prep routine, and some meals we enjoy making. Keep an eye out as I think this series will be helpful to people, especially fellow millennials.
Ultimately, we’ve examined these three areas closely. Are there ways we could cut down on the expenses? Yes, but we’ve gotten to the point where cutting down more would start to get painful. There’s not much excess that would be easy to cut.
Cutting Back on Small Expenses
So now what? After you’ve closely examined your large expenses, you get to the point where those three categories are pretty set. It becomes much easier to find small expenses to cut back on instead.
There are a number of advantages to challenging everything and focusing on cutting back small expenses. These small expenses are easier to implement and are more subtle life changes. Moving to a new house or apartment to save on rent completely uproots your life, but buying store brand items saves money and you hardly feel the difference.
Some examples of small changes we do include cooking at home, buying store brand items, choosing entertainment that doesn’t cost as much, and negotiating bills/switching providers (car insurance, Internet, cell phone). These changes are much easier for us to implement and they result in recurring savings every month, which is a much better use of time and money. Finding the small leaks in your budget help you discover immediate wins. This helps show that making small improvements in your financial life matter and saving money is doable.
Ultimately, it’s important to look at both the large expenses and small expenses in your budget. Both large and small expenses can have a big impact on your budget if you don’t look at them closely enough. Focus on what’s easiest for you to cut back on, and you’ll see improvement in your finances. Whichever you end up deciding, it’s even more important to focus on your mindset when it comes to how you’re spending money.