The Espresso Portfolio

15th March 2013

This is from Jim Parker, Vice President of Dimensional in Australia.  We like Jim because his articles provide great insight into how people behave around money.

We share his belief that the investor’s behaviour rather than investment behaviour will have the greatest impact on their wealth.  We cannot control what markets do, but we can control what we do.  In our experience, the combination of a robust investment process implemented in a disciplined manner is the best way to accumulate and protect your wealth.

Neil chose this particular article because he has cousins living in Melbourne with children at University (or about to go) one of whom took great delight in ‘facebooking’ him this morning to tell him how much they are enjoying the autumn heat wave.

We hope they have the good sense to start building their own espresso portfolios in due course.  They make great coffee in Melbourne, so it will be a bit of a challenge.

Image courtesy of Meyer Felix, Flickr

The Espresso Portfolio

When you haven’t got much capital of your own, the road to financial security can seem long, hard and complex. But the truth is that wealth building is relatively simple. All it takes is time and the price of a cup of coffee.

A son of a friend just graduated from university. Still in his early 20s and with student loans to pay off, Josh has hardly any savings or capacity to save much at all.

So Josh and I met for coffee and a chat. He had acquired a taste for espresso while studying and working nights waiting tables (the coffee kept him awake).

“How much do you spend on espresso each week?” I asked him. After thinking for a moment, he replied that he averaged about two cups a day, each costing $3. That equates to about $40 a week or $160 a month.

“Well, what if you sacrificed the coffee and put the cash into a savings scheme instead?” I suggested.

Josh looked doubtful. Kicking caffeine wouldn’t be easy. Besides, he couldn’t imagine that loose change spent on coffee would make much difference to his long-term financial position.

I dealt with the first problem by suggesting he make instant coffee at home and bring it into work each day in a flask. The second problem – that it wouldn’t be effective – I dealt with by telling him about the miracle of compounding.

With an initial balance of $100, a monthly contribution of $160 and a yield of 5%, his coffee money would gradually accumulate to a pool of a quarter of a million dollars by the time he retires. And this is without saving another cent.

Assuming Josh’s salary was to rise on his graduation, he might bump up that monthly contribution to $500. In this case, his savings pool would grow to three quarters of a million by the time he reaches retirement. And this is a conservative estimate.

The Espresso Portfolio

This sounds too easy, he said. That’s because it is easy, I replied. The interest he earns on his saving is paid into his account and included in the next calculation. So essentially, he was earning interest on his interest.

The key is firstly that he is starting early. Secondly, he is saving a small amount consistently, month after month. Thirdly, he will be exercising patience. The rest of it is just the effect of time and compounding.

(Obviously, this young man’s earnings will be subject to tax. But the purpose of this exercise is to show that a small sacrifice, made regularly, will yield significant results over time.)

Josh now refers to his savings plan as his ‘espresso portfolio’. The initial pain of kicking his expensive caffeine habit was made up for by the slow roast of a savings scheme that promised him a comfortable retirement.

Even for those of us much older than Josh, there are lessons here. We tend to underestimate the effect of gradual saving and patience in building wealth, just as we tend to over-rate gimmicks promoted in the media.

We can’t control the ups and downs of markets or the daily noise of the media. We can control our own behaviour. With slow and steady saving, and a trusted adviser to keep us disciplined, there is no reason we can’t succeed.

The Small Print

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. This article is provided for informational purposes and it is not to be construed as an offer, solicitation, recommendation or endorsement of any particular security, products, or services.

To find out how we can help you to start your very own ’espresso portfolio’, contact a member of the fortitude team.