By Barry Ritholtz
(Bloomberg Opinion) -- If you are like millions of other Americans, you spend a few dollars a week on a latte, cappuccino or some other type of luxury coffee. Does this amount to an act of personal financial irresponsibility that can add up to a future in which your well-being in retirement is at risk?The answer is, probably not -- with some caveats. But you wouldn't know that from personal-finance guru Suze Orman, who warned investors last week that this was sure to set you on the path to poverty in retirement.
Here's why I hedge: Everyone needs to save for retirement, because it almost goes without saying that if you're counting on Social Security to see you through the post-work years you are going to be very disappointed.
Yet, if spending $5 a day on coffee means the difference between financial security and penury, you have much bigger problems. Eliminating the daily latte or avocado toast will not get the job done.
So go ahead and indulge in the small things (the big things are a different story). But let's take a look at some of the issues that Orman brings up:
1. The power of compounding: Let's say you consume five lattes a week, spending a total of $100 a month. Now, instead of spending that you save it over the course of your 40-year working life, and earn a market return of 8 percent. According to the Securities and Exchange Commission's compound interest calculator, that works out to about $350,000.(Where I have a beef with Orman is her assumption that the saver would earn a 12 percent annual return for 40 years, ending up with savings of more than $1 million. That's not going to happen. )
2. Adjust for inflation: Note that the $350,000 is nominal, not inflation-adjusted. By 2059, assuming a modest 2.5 percent inflation rate, that nest egg will be worth a lot less -- $131,000 in today's dollars to be precise. Not all that impressive, but still not nothing. For some perspective, 40 years ago the median house cost about $62,000 (it's $317,400 today); median income was less than $20,000 ago versus $61,372 now.
3. Remove the denominator blindness: Numbers need context. That six-figure number achieved by cutting out lattes should be viewed relative to the rest of ones’ earnings and/or investments.
During the next 40 years, a moderate-sized portfolio with appreciation and regular contributions can add up to many millions of dollars. And a person’s lifetime earnings? If you earn the median income of $61,372 -- and never receive a raise for 40 years -- that adds up to $2.45 million. If you get a mere 3 percent raise annually, that becomes $4.63 million; 5 percent annual raises lead to almost $7.5 million in cumulative gross earnings.
4. Big fixed costs are the problem: No doubt, Americans do not save enough. We undoubtedly are looking at a retirement crisis for large numbers of people. Our leaders have yet to come up with good solutions to the impending problem.
Here's something else our leaders have bungled: Wages for U.S. workers have been little changed for three decades; economic mobility is declining; health-care costs keep going up faster than incomes; college tuition is prohibitive, with student debt exceeding $1.5 trillion. The costs of what we need keeps rising, while the cost of the junk we want keeps falling.
The problem with the fixed costs for things like housing and health care is that they are, well, fixed. They are very difficult or impossible to lower. Housing, health care and education are all expensive -- and necessary; coffee, even good coffee, is not.
So go ahead, cut out the coffee if you want. But that's a trifling issue and won't make much difference; the big things -- income, debt, economic mobility, inflation -- matter much, much more. Unfortunately, they are things that are beyond our ability to control.
Barry Ritholtz is a Bloomberg Opinion columnist. He founded Ritholtz Wealth Management and was chief executive and director of equity research at FusionIQ, a quantitative research firm. He is the author of “Bailout Nation.”
To contact the author of this story: Barry Ritholtz at [email protected]
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