Ian answers: Martha, your regular coffee won’t ruin your retirement fund. But it does highlight several important issues, including the way we tend to be reluctant to give up an indulgence now to benefit in the future.
A little cup of joy
Coffee is a popular example of non-essential spending – the type the “latte-nomics” brigade will likely say should be reduced, if not eliminated, to boost savings over time. If coffee costs €2, a month or year of costs is tallied and then a compound interest formula applied to show it grows to a significant sum over 20 or 30 years.
It’s fun to see how figures grow due to compounding – and it’s an important principle to understand – but why pick on coffee? And assuming you are putting money aside for a pension in the first place, it is unlikely that the extra you would accumulate by foregoing your latte will make the difference between penury or comfort in retirement. In contrast, not getting your coffee fix will almost certainly annoy you regularly.
There is a trade-off – something extra in your pension fund some time in the future or something pleasurable now. Who am I, or anyone else for that matter, qualified to advise you on how to make that choice? That said, the coffee and saving choice can help demonstrate some behavioural aspects that illuminate some ways people manage their money.
The coffee budget
The simplest thing to consider is whether you really can afford your coffee habit. It is not a question of whether you know how much you are spending on coffee alone but whether you know how much you are spending and saving in general. In other words, do you have a budget?
One of the simplest ways to manage personal finances and savings is to know how much is earned and spent. However, many people do not take this first, essential step. It’s easy to understand reasons for this. Procrastination has been identified as one of the greatest enemies of personal financial planning. After all, there are many much more fun things to do than sit down and work through old bank statements. If you have an accurate budget (which includes pensions and other long term savings goals) you will have a much better idea of whether you need to cut back on your coffee habit – for financial rather than health reasons.
Changing income and changing coffee
If crunching the numbers shows that a daily coffee is too much of a stretch (or if your financial circumstances change and you need to cut spending), be strong and put your long-term goals ahead of a short-term caffeine hit. It can be difficult to adjust to a new situation, partly because of what is known as anchoring and adjustment in behavioural economics.
Anchoring suggests people get used to living in certain ways and adjusting to changes is difficult – not only emotionally but mathematically as well. We tend to “anchor” spending on past behaviour and what others are doing rather than what the numbers say. In addition, we often like to be rewarded now rather than in the future. And, because of this hyperbolic discounting, we can “discount” the importance of choices the more distantly they fall in the future. So it could pay to spend more time thinking about your retirement fund than your latte.
A wake up call
All of the above assumes that you are saving for retirement in the first place. However, if you are not, you will need more than a strong shot of coffee to wake you up financially.