If you are a consumer of personal finance content like I am, you have by now undoubtedly heard one commentator or another derisively dismiss the idea of even mentioning the long-term cost of a daily Starbucks trip. They don’t want to hear about it—it’s a trope to be ignored. And this derision is coming from otherwise competent and professional personal finance sources. This phenomenon got me thinking: what’s going on here? Surely Commentator X understands time-value calculations and the concept of compound growth, and that the output of this math is objectively real. Right?
I recently came across a (now somewhat dated) podcast by personal finance and investing commentator/writer Rob Berger discussing the idea of a backlash against so-called personal finance gurus like Suze Orman, Dave Ramsey, and David Bach. (Rob also wrote a great piece with a similar theme for Forbes.com all the way back in 2017). It was here that I learned that one of these personal finance gurus, David Bach, had actually written a book called The Latte Factor that goes into great detail about the financial power of small savings over time (apparently I’m behind in my reading; The Latte Factor was published back in 2019). The fictional tale chronicles the journey of the protagonist, Zoey, on her journey from latte-guzzling, broke twenty-something to financially independent (but presumably latte-deprived) world traveler. In his discussion of the backlash against the gurus like Bach, Berger posits the persuasive theory that one motivation of the guru-antagonizers may be the desire to avoid losing an excuse for not assuming personal responsibility for financial outcomes. That is, if the gurus are right and I can significantly impact my financial situation by changing small consumption habits that are within my control, then I can no longer tell myself or anyone else that my financial condition is outside my control. Therefore, the gurus cannot be right.
Locus of Control
This idea brings us back to the psychological concept of “locus of control.” We have previously discussed this concept in some detail, and we explained the concept of locus of control as the personality characteristic that differentiates those who believe they can control the outcomes in their lives (financial and otherwise) from those who believe instead that things outside their personal control happen to them.
The belief that I do control my outcomes is referred to as an “internal” locus of control; the belief that I do not control these outcomes is referred to as an “external” locus of control. The American Psychological Association explains it this way: “People with an external locus of control tend to behave in response to external circumstances and to perceive their life outcomes as arising from factors out of their control. People with an internal locus of control tend to behave in response to internal states and intentions and to perceive their life outcomes as arising from the exercise of their own agency and abilities.” Our research at DataPoints indicates a strong positive correlation between an internal locus of control and positive wealth outcomes. From The Next Millionaire Next Door:
Those who are financially independent focus on their own choices, taking responsibility for their money-related actions and behaviors.
The Next Millionaire Next Door, p. 58.
Books and related research including most notably the original The Millionaire Next Door tend to take on the role of a sacred text for individuals with an internal locus of control in relation to their personal finances. Even if they have not accumulated meaningful wealth yet, seeing real-life, real-world data supporting the conclusion that significant wealth can be amassed without a huge income or an inheritance or other windfall serves as valuable encouragement. The internal locus of control set reads: “Keep going! It will work!”
Writings such as Pound Foolish: Exposing the Dark Side of the Personal Finance Industry, on the other hand, appear to serve as the sacred text for the external locus of control set. In Pound Foolish, author Helaine Olen does an absolutely masterful job of enumerating in exquisite detail all of the foibles, errors, conflicts of interest, and other shortcomings of the personal finance gurus such as Orman, Ramsey, and Bach (and everyone else in the personal-finance industrial complex). It’s a great read, and Olen is a great writer. It’s also a welcome reminder that you will often learn much more in listening to someone with a contrary viewpoint than to someone with whom you agree on all things.
While there were boatloads of points of agreement with Olen’s writing in Pound Foolish—for example, Olen calls out the absolute criminal lunacy of allowing commission-based “financial advisors” to masquerade as unconflicted counselors through use of smoke and mirrors (or opaque legal regulation)—she ultimately builds to the apparent conclusion that you can’t materially impact your financial outcomes by foregoing that daily Starbucks visit (or by doing anything else). So don’t even try. The external locus of control set reads: “You can’t do it! Don’t even try!”
Back to the theory of the relationship between the guru backlash and locus of control. While recently reminded of this phenomenon by Rob Berger, it isn’t new, and one that we’ve experienced first-hand before. We’ve told the (hilarious?) story before of discovering a copy of The Millionaire Next Door violently thrust into a toilet at Hartsfield-Jackson International Airport in Atlanta. Did this person prefer the cold comfort of the external locus of control perspective to personal finance? Maybe.
Warranted Criticism of the Gurus?
Some of the criticisms directed at the small-savings-can-lead-to-big-amounts concept are warranted. Using a 12% rate of annual return to make your result conspicuously large, for example, should draw some criticism. Advising people to forego all of life’s small pleasures as a means to attaining future financial security is sadistic (and maybe more importantly, not sustainable). And yes, if your entire plan for financial security is to forego your daily cup of joe, the plan isn’t going to do you much good if you’re hit with a costly healthcare emergency in year three of the process.
But none of these criticisms undo the basic operation of the compounding math that is being leveraged here. While 12% annual growth may be unreasonable, over the long haul 7% certainly is not (and 7% still leads to a really significant pile of cash at even very small savings levels). Yes, a stash of $50,000 from latte savings won’t overcome all by itself a six-figure medical emergency—but it’s still $50,000 with or without the medical emergency. Are you better off with or without the pile of cash, whatever the size (even if used in total to reduce the medical liability)?
The point here is that no one has offered an argument to undo the operation of the future value calculation in the spreadsheet. Plug in the inputs and you get the gloriously magical outputs. Every time.
Since a piece discussing compound growth calculations wouldn’t be orthodox (or any fun) without some numbers and charts, let’s throw one in. Here’s what happens to a monthly savings amount of $100, $200, and $500 in savings at a 7% annual growth rate:
Some of us look at an image like this and our heart sings; others may curse the gods. But love it or hate it, it’s true. It’s real. Ignoring it doesn’t change the result. At least not the result of the abstract math computation—but it undoubtedly will change your personal result. As Vanguard pointed out in a humorous tweet some time ago: the expected future value of zero in savings is, well, zero (accompanied by an amusing graphic of an x and y axis with zero data populating the field).
It’s hard to consider information of this sort and not come away with the conclusion that you are—at least in part and to some extent—responsible for your personal financial outcomes. Of course there will be real-life variables that will change the ultimate result. We won’t experience a smooth 7% annual growth rate (but over time the average rate of return will end up here—or better). Yes, there will be some months and years where you’re not able to save the target amount (so be on the lookout for those years where you may be able to save more). None of these variables change the fact that small amounts saved for long periods of time can add up to large amounts. For some this may be uncomfortable because it removes an excuse to avoid being financially responsible to whatever extent you are reasonably able, notwithstanding life’s unpredictable ups and downs.
Double Chocolate Café Mocha and Locus of Control
As noted above, our research reveals a significant correlation between internal locus of control and wealth outcomes, specifically net worth (independent of age and income level). Our data has uncovered a significant correlation between internal locus of control individuals and savings rate. Higher internal locus of control equals higher savings rate, which in turn significantly correlates–not surprisingly–with increased wealth accumulation. Controlling for inherited wealth (in other words, removing the effects of getting money from rich relatives), those household CFOs who disagree with the idea that life experiences keep them from being wealthy have a significantly higher net worth than those who agree with this statement. Here is a slice of what our survey data shows, focusing specifically on the correlation between net worth and the belief that external factors have in the past and/or are currently preventing wealth accumulation:
And we’re not the only researchers to spot this connection.
An academic study published in 2016 in the Journal of Banking and Finance (abstract available but full study behind pay wall) found a material disparity in wealth accumulation results between an internal locus of control group and an external locus of control group. Not surprisingly, the disparity in absolute terms was largest between the internal locus of control and external locus of control groups in the wealthiest households, but largest in relative size in the poorest households. In this latter group of poorer households, internal locus of control households enjoyed on average 40-60% more accumulated wealth than the external locus of control households.
These results make some intuitive sense. If you accept (or believe) that you can, through your own actions and decisions, affect your personal financial outcomes, you are more likely to take action. Concluding, on the other hand, that it’s all outside of your control and subject to the whims of fate allows you to blissfully take no action at all.
Make Peace with the Latte
Like it or not, an individual’s willingness and ability to accept and assume responsibility for their future personal financial outcomes bears a significant relationship to realized outcomes. Some more naturally take to this reality than others. This is where an individual’s honing of the skill of distinguishing between “things that don’t make me happy” and “things that aren’t true” is critical. (Note: they’re not necessarily always the same thing.)
Small amounts saved consistently over long periods of time can’t guarantee financial success—life still happens in unpredictable and at times disastrous ways—but it can create a significant possibility of success that wouldn’t otherwise exist. The results of the compounding calculation exhibited in the chart above are going to turn out the same in the presence or absence of unplanned life emergencies, and even if such an emergency wipes out your accumulated savings to date, it’s hard to make the case that anyone would be better off without the accumulated savings. And the math doesn’t change even if Suze Orman is getting rich selling stuff along the way.
The personal finance gurus don’t get it all right, and we shouldn’t operate under any illusion that they are saints or not-for-profit operations. Even if we can’t testify to the purity of their ultimate motivations, we can certify their arithmetic.