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Rethinking The Latte Factor®

The Automatic Millionaire, written by David Bach is one of my favourite books on personal finance. I highly recommend the Canadian edition. Bach is the founder of The Latte Factor®. You’ve probably heard it a thousand times. Those small indulgences add up over time.

Just for fun and for purely research purposes I took a little trip down to my local Starbucks. I’m partial to cappuccinos but for this purpose, I thought it best to order a tall latte. The grand total including tax was $3.26 Based on the assumption that I might buy one 5 days a week on my way to work, that’s $16.30 a week or $847.60 a year if I went 5 days a week, 52 weeks of the year. $847.60 a year invested over the next 10 years at a conservative 5% would turn into $10,661. Over 20 years the grand total would be $28,040! That’s a lot of money.

Every day we spend money on little things that give us pleasure. There is nothing wrong with spending money on things you enjoy. In fact, I’d encourage you occasionally to spend more money on things you enjoy. You may find that it increases your quality of life. Buying a latte each and every morning does nothing for me. Yet, if it really adds something to someone else’s life, who am I to discourage them to cut back.

Three of my favourite things are Thai food, music and movies. In fact, I could spend every Friday night eating out at my favourite Thai restaurant followed by live concert or film festival. I could do the math on it and realize that if I saved the amount I spend on Thai food, music and movies, invested at 5% over my life I’d have a lot more money. I’d also have a lot less pleasure. I also like books and I don’t always get them at the library (gasp!).

I wonder sometimes if we’ve been focusing too much on the little savings when sometimes it’s the little things that bring joy to our lives.

Here are 6 relatively painless ways you can bring the latte (or whatever small indulgence you’d like) back in your life.

  1. Cut cable if you don’t watch much TV. Basic cable with Rogers is $37.82 after taxes in my area. If you have the movie network or rent a PVR, the savings will be even higher.
  2. Clean your own house or mow your own lawn. Which would you rather have, the latte or help around the house? Me? I’d rather have the help which is why I make my own coffee and hire someone else to shovel our sidewalk.
  3. Cancel things you don’t use. Have a gym membership that you never use? A newspaper subscription that you hardly get around to reading? A shopping membership to a place you never go? Take the time to review your monthly payments and cancel what you don’t use.
  4. Cut back on fees. Switch to a no fee credit card and no fee banking. You’ll have plenty of pain free extra money for small indulgences.
  5. Compare car insurance rates. When I took the time to call around and compare insurance rates, I was shocked at the difference. It took a couple of hours to make all the calls and give all the information they needed. In the end we saved over $350 a year by switching.
  6. Pay off credit cards. Do the math on how much you pay in interest payments each month. For many people, they are stunned when they add it all up. It’s motivating to get it paid off sooner when people consider the true cost of things purchased on credit. It’s that much extra money in your pocket each month to do with as you wish. I’d rather have a latte than pay my bank more money for something I bought last year.

There is nothing inherently wrong with lattes. Bach had it right when he wanted us to be conscious of our spending. By tracking the little expenses we have the opportunity to reflect on whether our money is being spend where we want it to go. Be careful though that you don’t remove all of life’s little pleasures in the name of being frugal. Life is for living and it’s difficult to live a full life when counting the cost of every little indulgence.

Kathryn has been a staff writer for MDJ since January 2009. During the day she works in an office. In her off hours, she volunteers as a financial coach helping ordinary Canadians with the basics of money management. Kathryn, along with her husband and two children live in Ontario.

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Avatar About the author: Kathryn has been a staff writer for MDJ since January 2009. During the day she works in an office. In her off hours, she volunteers as a financial coach helping ordinary Canadians with the basics of money management. Kathryn, along with her husband and two children live in Ontario.

{ 47 comments… add one }
  • Avatar Gary January 25, 2010, 9:04 am

    Where do you invest your money to get a 5% return? “Conservative”

  • Avatar Big Cajun Man January 25, 2010, 10:14 am

    Frankly keeping my money is good enough. If I use that extra money to pay off debt then I really AM getting 5% back on it :-)

    If I am completely debt free then I’ll worry about how much return I get on my money.

  • Avatar 2 Cents January 25, 2010, 10:20 am

    I like that you used a 5% return rather than the 10% that Bach is in the habit of promoting. The past decade shows that to be an unrealistic assumption. Let’s hope 5% is not out of the question. If stocks can’t deliver that, what’s the point?

    You make some great points on trimming things that aren’t really important to you so that you can enjoy the things that are. (I’m with you on the restaurants, music, and books!) ;)

  • Avatar Mike January 25, 2010, 11:01 am

    Love the latte factor analogy by David Bach.

    Back a couple of years ago, he was giving a free presentation on this concept in our city (Hamilton). One of the best presentations I’ve seen and it really reinforced the concept. Highly recommend if anyone has the opportunity.

  • Avatar Nelson January 25, 2010, 11:42 am

    I get 1.2 % if I’m lucky. I don’t know where that 5 % comes from but I would like to know.

  • Avatar No Debt Guy January 25, 2010, 11:56 am

    I would agree that you have to enjoy life once and awhile, but you have to do it within limits. I know people that are drowning in credit card debt but still have their two lattes a day.

    Maybe I am too stringent, but if I was carrying any credit card debt I would be living bare bones until it was paid off. My only entertainment would be seeing the balances on my credit cards decrease. :)

  • Avatar Stephen January 25, 2010, 12:04 pm

    LOL @ No Debt Guy … sounds like great entertainment :)

  • Avatar Kyle January 25, 2010, 12:04 pm

    Can’t find a 5% return? Look beyond savings accounts and GIC’s and you’ll Kathryn’s conservative estimate of 5% is more than reasonable for this example. BMO’s common stock has just over 5% dividend yield based upon current stock prices. (not a recommendation, just an observation)

  • Avatar Sampson January 25, 2010, 12:35 pm

    I’ve never bought into the ‘Latte factor’ – like you Kathryn, I’m very partial to espresso based drinks, but I make my own -never realized I was saving $800+ per year. I’ll use this little tidbit with my wife to upgrade my machine. ;)

    Cutting down on lattes, cable tv or the little things CAN reduce your spending, but it still all ties together into the simple little equation.

    Money out < Money In

    I personally think more substantial savings can be made on larger items, houses, cars, etc. I would never cut down on the little things I enjoy, they are a big part of what makes life enjoyable. There are just easier ways to save than 'cutting' things out.

  • Avatar eRick January 25, 2010, 12:51 pm

    Kathryn, I like your articles. I think they are great … this is just another one!

    I’ve always been of the belief that “it’s not how much money you make, it’s how much money you spend” which will determine your future financial security/follie!

    Your articles are practical and your advice responsible!

    Thank you.

  • Avatar Dwight January 25, 2010, 1:20 pm

    Good Article, I feel its about using YOUR money where YOU want thats the key, thinking long-term about expenses can really put things into perspective. We also cancelled our cable about 6 months ago when we realized we were paying $700/yr for something we dont really use, I built a digital antenna and I get cbc and other channels in high def! and its that much more rewarding to know its free.


  • Avatar canucktuary January 25, 2010, 1:21 pm

    I’m pretty sure the guy at work who buys 3 Starbucks a day has never heard of the Latte Factor…maybe I will enlighten him. :)

  • Avatar Alias bob January 25, 2010, 1:22 pm

    I get a different result for the compound interest.

    Using M=P(1+i)^n
    P=$847.6 ; i=0.05 ; n= 10 gives M=$1,380.65

    How did the approx. $10, 000.00 result get calculated?

  • Avatar Brian Drolet January 25, 2010, 2:04 pm

    I love this approach to spending. Ramit Sethi talks about Conscious spending often as well. Something very important to me :)


  • Avatar Sampson January 25, 2010, 2:20 pm

    Alias bob,

    Its not $847.6 in the first year only, its $847.6/year for ten years. Assuming the money is held as cash, 10 years worth is already $8476.

    One additional consideration is that costs for these types of ‘vices’ typically increase at rates greater than inflation. Sure Timmy’s double double only increased by $0.15, but that’s near 10% in a single year.

  • Avatar Craig January 25, 2010, 2:24 pm

    I never liked that philosophy, in theory it makes sense, but not really. If you really enjoy something, keep on getting it, just sacrifice somewhere else.

  • Avatar Dirac January 25, 2010, 3:14 pm

    @ Sampson:

    Though you are very correct in that you will save more on the big things, I think this concept of a latte factor is also about self discipline and effort. If one concentrates on the small things, then when the big purchase comes along, it should be a part of you to get the best value.

    I love strong coffee drinks and in the base floor of our building we have a fantastic coffee shop but it will cost $4 each time I enter. I found that when I did not care so much (see lazy) I would enter almost every day and get my fix. I also tended to hit amazon.com and half.com a lot more. Now that I am making an effort to stop the minor purchases, I am more mindful of the big ones.

    I think of the latte factor as the training for the marathon.

  • Avatar Alexandra January 25, 2010, 3:41 pm

    Sorry, but the math is SO wrong. You have to account for the fact that if you skip buying the latte, you replace it with one you bring from home. Your savings are actually the cost of the latte bought at the store, minus the cost of that same latte made at home.

    Unless I am mistaken.

    If so, please post where you get the free latte maker, sugar, milk and coffee grinds – I’m up for a good bargain!

  • Avatar Kate January 25, 2010, 3:51 pm

    Coffee is also bad for one’s health, so you would gain some benefits here, too by cutting it. The area I personally have troubles cutting is travel but my excuse is that I am living for it.

  • Avatar Mike January 25, 2010, 4:06 pm

    Latte is probably a bad example to use considering anyone buying one/day has a drug addiction (albeit a minor one) and is probably not prone to being swayed by rationale arguments about compound interest.

  • Avatar Joan January 25, 2010, 4:32 pm

    I rue that I spent $5 a day to satisfy my tobacco addiction over the 20 years that I smoked. I’m a few years from retirement and would, very much, like that money now.

  • Avatar Ms Save Money January 25, 2010, 4:34 pm

    I recently moved into a new place in November – & I’m realizing I’m spending more now than I am before – because my roommates and I split the cable, & all that good stuff. – the only thing is that I don’t watch tv & I’m paying for stuff that’s irrelevant to my life. This is definitely getting into the way of me spending on the things that I find joyful.

  • Avatar CPS January 25, 2010, 4:37 pm

    This is a great article. I read a lot of Personal Finance blogs and it does seem to me that everything is geared towards saving money and having little fun now to enjoy life later.

    I don’t necessarily believe in the “delayed gratification.” As long as you’re paying yourself first, and have relatively good budgeting skills you should indeed treat yourself every now and then.

    The Latte Factor is great for people new to personal finance and trying to get spending/debt under control.

  • Avatar Kathryn January 25, 2010, 4:56 pm

    For those wondering how I did the math, I use http://moneycentral.msn.com/personal-finance/calculators/aim_to_save_calculator/home.aspx with a 0% marginal tax rate because I’d be investing it in a TFSA.

    2 cents and others had it right. The ‘conservative’ figure is lower than Bach’s estimated 10-12%. Where do I hope to make 5% in the next ten years? I hope my investments do much better than this! I simply used the 5% as a conservative estimate.

    Yes, it’s true I could have deducted the cost of coffee grinds and electricity from that amount but a 1 kg tin of Great Canadian Coffee lasts me a couple of months. I just make sure I get it when it goes on sale. I figure I save that much alone in gas by not swinging by Starbucks so it all evens out in the end.

    Graig: You summed it up well in one sentence.
    “If you really enjoy something, keep on getting it, just sacrifice somewhere else.”

  • Avatar Sampson January 25, 2010, 6:00 pm

    @ Kate,

    The research on coffee actually suggests that 1-3 cups of black coffee per day can reduce your risk of diabetes, Alzheimer’s, and Parkinson’s diseases, and has absolutely zero impact on cancer incidence rates.

    A lot of research is done in this area, but very little (miniscule) actually shows that it is harmful.

  • Avatar Caitlin January 25, 2010, 6:01 pm

    I cut my cable almost a year ago, and I haven’t missed it. Ok, so I have missed it a little, but what I don’t miss was the $75/mo price tag. I put that towards my a loan I owe instead of a small pleasure, though, and I’ve been watching that loan balance fall like a stone since then. It’s given me more pleasure than any ol’ latte!

  • Avatar RetirementInvestingToday January 25, 2010, 6:33 pm

    The other thing that amazing me about Starbucks is how they maximise THEIR latte factor to match your earnings and ‘standard of living’. If you’re from a lower earning band then you might go for the flat white where if you are from a higher earning band then you might go for the caramel macchiato with an extra shot of espresso. Compare the price differences.

    I like your 6 suggestions for bringing the latte back in your life. I’m practising all of them. Well not quite – I don’t have cable or a car so maybe I’m cheating a little… Maybe that’s how I’ve managed to be saving around 60% of my gross earnings into my retirement investing strategy.

  • Avatar Ken January 25, 2010, 6:38 pm

    You are so right about having some flexibility in the budget. All work no play..not gonna work over the long haul.

  • Avatar bob January 25, 2010, 7:26 pm

    5% conservative return?! You’re dreaming unless you are talking about pre-tax and pre-inflation, in which case you are setting the bar too low.

    S&P/TSX Composite Total Return Index (including dividends but pre-tax and pre-inflation)
    * 10 years to August 31, 2009 – 9.41%
    * 20 years to August 31, 2009 – 8.86%
    * 30 years to August 31, 2009 – 10.76%
    * 40 years to August 31, 2009 – 9.77%
    * 50 years to August 31, 2009 – 9.80%

    Subtract 1-2% for MER
    Subtract 2% for inflation
    Subtract 1-2% for taxes
    Subtract 1-5% unless you are 100% invested in equities

    = a whole lot less than 5% . . .

  • Avatar Gary January 25, 2010, 7:30 pm

    A 5 % return would be great. I don’t understand this “conservative” part. Where do you put your money to get such a good return?

  • Avatar Chris January 25, 2010, 11:09 pm

    The people forced to live & work with me will all agree that I should continue to have my morning coffee. Guilt-free, I might add.

  • Avatar Ed Rempel January 26, 2010, 3:30 am

    Hi Kathryn,

    Great article. I agree that spending on the things you really enjoy is how you should use your money (assuming you can afford it).

    I can add to your list of ways to save money painlessly, so you can spend it on what you enjoy. Here are the 4 most expensive wastes of money we commonly see:

    1. New cars – You can get a reliable used car for half the price if you buy 2-4 years old. The depreciation in years 1 & 2 is huge. The rule of thumb is that the depreciation in the first hour you own a car equals all repairs & maintenance for the life of the car.
    2. “5-year Fixed Mortgage Trap” – The average Canadian wastes $23,000 after tax during their life because they fell into the Trap and took a 5-year fixed instead of a variable or 1-year (based on a study by Manulife). I believe that every single Canadian that every took a 5-year mortgage wasted money (based on a study by a mortgage broker comparing 1-year to 5-year mortgages since 1950).
    3. Credit card interest – You have this right.
    4. Too many renovations – Many people spend far too much on renos and don’t realize that usually only 20-40% of the cost is added to the value of the home (unless you DIY). Most of the cost is for your personal use.

    The new car and renovations might be something you really enjoy, so perhaps spending money on it is still worth it to you, but these are expensive and common ways to waste money.


  • Avatar youngandthrifty January 26, 2010, 3:41 am

    I really liked the book Automatic Millionaire too! And I am always conscious of the latte factor… me and my wallet are thankful that I’m not addicted to coffee. I do like going out to watch movies though, and eating out is my vice, but I don’t do things ‘daily’. I always try to bring my lunch, too. Eating out is a big budget-sucker. $8 a day x 5= $40 a week, a little over $2000 a year! So since my indulgence is travel, I always bring my lunch and give myself that allowance to put into my travel budget.

  • Avatar used tires January 26, 2010, 8:10 am

    Most of my hobbies/interests aren’t that expensive. Even so, I also look at everything from an economic angle. A little thinking every step of the way will save you a lot at the end. But never to the point where the enjoyment is sapped out of your life.

    Till then,


  • Avatar Future Money-Bags January 26, 2010, 11:09 am

    I don’t drink coffee for a few reasons:
    1. It is a huge waste of money, and I compare it to smoking. Yes, I went there.
    2. Although I do enjoy it on occasion, It does not ‘wake me up’ or ‘revitalize me’ for more than 30 minutes. I believe this is a misconception to many people and after consuming coffee every day; their bodies soon rely on it to function at full capacity of 100% each day.
    3. It makes my teeth yellow. Maybe this is just me, but its another reason for me to not want to drink it.

    I will also never drink at clubs/bars, as $5-9 for 1 drink is a huge waste of money. Why not buy from store and drink at home before going out?

    I do eat out sometimes, but not when I don’t have food at home. This puts the idea in your head that when you have no food, you have to go out and eat. Making food at home is enjoyable (more so with someone else), maybe because I cook for a living?
    This also means I am able to eat at work, for free, meaning I save a tonne of money!
    $8/day * 6 days * 52 weeks = Nearly $2,500/year just on 1 meal a day.

    But some of you argue that you would rather keep eating out and buying that coffee? It’s a low risk investment, that pays high.

    Ps. I agree 5% is a conservative number. There are many places to invest that will yield a much higher Percent. They are higher risk than a GIC or Dividends, and you need to keep them for more than 1 or 2 years.

  • Avatar Bill January 26, 2010, 6:18 pm

    “I will also never drink at clubs/bars, as $5-9 for 1 drink is a huge waste of money. Why not buy from store and drink at home before going out?”

    Even safer is wait till you get home to drink.

  • Avatar JK January 26, 2010, 9:00 pm

    The lunch factor is a killer… in Vancouver where a meal and a pop can set you back $10 per day. Take that and times it by 22 working days = $220 a month!

    I am indeed a coffee drinker but fortunately my employer is providing semi-strong coffee that will take care of my fix.

    Discipline and sheer will power is the key!

  • Avatar Future Money-Bags January 26, 2010, 10:25 pm

    Hey Bill,

    Its not a matter of being safe, I am a responsible person.
    I work 6-7 days a week and only ‘go out’ every couple weeks. I will be 25 soon and I have always known planning for the future is more important (for me) than just having as much fun doing whatever I want. There’s a reason 90% of people my age don’t have over $5k saved.

    That being said, there is a cheap alternative to everything you deserve. It may not be quite as appealing as the latter (or the latte) but it can still fulfill your ‘gotta do it!’ fix.

    Jk, I reside in Vancouver as well. And being as expensive as it is, by making small sacrifices and being ‘frugal’, you will find its not so hard to save money. Although many breakfast places cost $12+ for a meal, there are a good few that are under $8 and even under $5 for the same quality of food guaranteed.
    Don’t have to eat at Colby’s steakhouse every night ;)

  • Avatar Kathryn January 26, 2010, 11:50 pm

    Good points about the lunch factor and the drinks out factor. Those numbers add up a lot faster than lattes!

  • Avatar Gates VP January 30, 2010, 4:21 am

    Hey, I’m late to the party, but I’ll pipe in and remind people that “Automatic Millionaire” is really bad book.

    Glaring problems:
    – The book contributes basically nothing that is “new” or “original”.
    – All of his book numbers are based on unrealistically high returns. If the market is paying 10%, what the heck are you doing paying down your mortgage quickly.
    – He practices lots of bad “inflation-free” math while still talking about retirement. Talking about “dollars” and then “30 years from now” is just a poor way to explain it. We know that people are bad at correctly fathoming those types of numbers.
    – Paying down a mortgage quickly is actually a large risk for many people, especially in 2010 in the age of the highly mobile worker. Let’s face it, if you have 5k in your pocket with a mortgage on one side and an empty emergency fund on the other, you put the money in the emergency fund. Houses are very illiquid and this current crisis strongly demonstrates the problem of being “pinned” to a location.
    – He relies heavily on the 401k as an investment tool. The RRSP is a very good tool, but the 401k is an anemic tool for many people. It’s far from automatic, often carries a higher overhead (costs and personal time) and lots of employers are doing only small matches these days (if any).
    – He also makes mistakes in the way he calculates 401k growth.
    – He relies heavily on stock market investments ignoring the fact the average worker will see significantly better return by investing in education.
    – He regularly insists that “regardless of the size of your paycheck, you probably already make enough money to become rich”. This is trivially false for most definitions of “rich”.
    – His suggestions for wealth creation involve saving large amounts of your personal income. It’s the same problem as the wealthy barber.
    – His “Latte Factor” concept completely ignores the fact that now you’re not getting your caffeine. He’s constantly “eliminating waste” without quantifying the waste. In fact, his whole “Latte Factor” concept assumes that you have enough that you are wasting significant amounts of resources that should instead be scuttled away.

    Instead of talking about the things you could be doing with your money, or even aligning your monetary spending with your priorities in life, he just focuses on telling you to stop drinking not lattes. Note that he never suggests that you make lattes at home, just that you stop spending the money all together.

    This book isn’t just bad, it’s harmfully misleading.

  • Avatar Kathryn January 30, 2010, 7:42 pm

    Wow, Gates VP, how do you really feel? :-)

    I agree with many of your points. It’s nothing new or original because it’s an older book. I agree that he exaggerates estimated rates of return which he believed more likely to come true at the time of publishing. For anyone whose read the Wealthy Barber lately, it’s even more out of date!

    The thing I like about David Bach is that he has a passion for personal finance and communicates clearly. It’s simple personal finance. I simply don’t see how saving 10%-18% of your income for the future is either harmful or misleading.

  • Avatar cannon_fodder January 30, 2010, 8:57 pm

    For those with an issue with the 5% return think of it this way: take whatever you had planned to spend and apply it to your historical rate of debt. If it is a mortgage that might be at least 5% since the current rates are historically low. Maybe you have other debts such as car loans or credit card debts.

    And remember these would be with after tax dollars so it removes that consideration.

    Or perhaps think of it this way – you make $50,000 per year and you get a 2.5% raise. After taxes perhaps you net $750 of the $1,250 raise. Well by eliminating your daily “insignificant” expense you have provided a similar benefit to a better than inflation raise.

  • Avatar Gates VP January 31, 2010, 9:32 am

    @Kathryn: I simply don’t see how saving 10%-18% of your income for the future is either harmful or misleading.

    It’s misleading when you think that it’s going to make you rich. It’s misleading to tell a person making 20k / year that ““regardless of the size of your paycheck, you probably already make enough money to become rich”.

    It’s misleading to assume stock market growth rates that are triple the GDP and then to ignore inflation when we just spent 15 years at a steady 3%. He basically presents impossible numbers to under-educated readers. The only major countries growing anywhere close to 10% are India and China. And that’s post-inflation. None of the G8 countries have experienced even 5% GDP growth in the last few years. If a country is growing at 2% or 3% / year, how is the “average” person in that country supposed to grow their investments by 10% (or even 5%)? Sure, some people will pull it off, but how can everyone?

    It’s misleading to use compound growth numbers on non-compounding investments. Non-dividend stock growth doesn’t “compound”. It’s constantly going up and down. At best you hope it grows enough to “be there” when you need to cash out. (maybe you’ve noticed the 12-year death spiral on US stocks?)

    It’s misleading to ignore inflation when we know (based on scientific research) that people are very bad at comprehending numeric inflation over long periods of time.

    It’s misleading to tell people that they should “pay down their mortgage fast” when the numbers don’t really support this. In fact, there are lots of good reasons not to pay down your mortgage right away. If you’re successfully saving that 18% of your income and you’re doing continuous professional education and you still find yourself with money at the end of the month, then maybe it’s time to start paying down the mortgage. But the % of the population capable of doing this is very small.

    Look, don’t get me wrong, I save 10%+ of my income and I’m making well over the median number. But I don’t in any way believe that it’s somehow going to “make me rich”. At best it’s provided a small buffer for a big life event. I’ll probably be able to afford the retirement I want, but it’s definitely nothing like the 25-year retirement he’s selling in the book!

  • Avatar Gary January 31, 2010, 12:56 pm

    “If a country is growing at 2% or 3% / year, how is the “average” person in that country supposed to grow their investments by 10% (or even 5%)? ”

    I would like to know that too. The article calls the 5% return a conservative estimate. How am I supposed to make that much? Or even more? In the world we live in today, I don’t think many people can get there. I know I can’t. And whenever I ask the question, I get no answer.

  • Avatar Jess Valenzuela January 31, 2010, 4:29 pm

    “Three of my favourite things are Thai food, music and movies”

    We have the same Guilty Pleasure! lol… Is Pad Thai one of your favourites? lol..

  • Avatar Ed Rempel January 31, 2010, 5:35 pm

    Hi Gates & Gary,

    Comparing GDP and investment returns is not apples to apples. Stock market returns long term are about triple GDP, which is to be expected.

    @Gary “If a country is growing at 2% or 3% / year, how is the “average” person in that country supposed to grow their investments by 10% (or even 5%)? ”

    It may seem obvious that if an economy only grows by 2-3% (after inflation), stock markets must be limited to this, but that is a misunderstanding. GDP is based on total production, which would be the sales of all companies. The stock market is based on a multiple, say 15 times, the profits.

    It sales grow by 2-3% plus inflation, profits normally grow at a much higher rate. This is because all companies have fixed costs. For example, if a company has half its costs fixed and half variable, a 5% sales increase would normally increase the variable costs by 5%, but not the fixed costs, which would mean the profit would increase by 10%. The typical stock prices is a multiple of the profit.

    This is why stock markets grow far faster than the economy.


  • Avatar Man From Atlantis January 31, 2010, 10:09 pm

    Here is a chart that compares stock returns to GDP

    http://www.crestmontresearch. com/pdfs/Stock%20Economy.pdf

    They have some other neat stats on the site if you are into that sort of thing.

    I put a space before com, othewise it didn’t seem to work?

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