I always enjoyed reading books on self-development and financial literacy. One of my favorite books in my collection is David Bach’s, “The Automatic Millionaire”, first published in 2003.
“The Automatic Millionaire” stands out for its simple philosophy—that you don’t need to earn a fortune to accumulate wealth. Instead, it’s about managing whatever you earn smartly and efficiently. Here are the key lessons which you can takeaway.
1. The Latte Factor
“The Latte Factor” is the famous term coined by Bach in the book. This is the principle that small daily expenses, like a latte, can add up over time. And saving and investing these small amounts can lead to significant wealth over time.
The point of The Latte Factor is to bring awareness to our unconscious spending habits. For instance, spending $5 on a daily latte at Starbucks might seem insignificant, but if you were to save that $5 instead and invest it, it could grow to a lot more over time.
Let’s apply this. Say you were to invest that daily $5, which equals to saving $1,825 a year. If you then invested that $5 per day at an annual growth rate of 10%, compounded over 20 years, you would have amassed $116,785.
So, while you’re only spending $5 on a latte every day, you’re foregoing $116,785 over the long term.
2. Pay Yourself First
A key principle in the book is that “the rich get rich (and stay that way) because they pay themselves first.” The concept of paying yourself first is not new. This is the fundamental principle from “The Richest Man in Babylon” by George S. Clason.
“The Automatic Millionaire” begins with the story of an average American couple, Jim and Sue McIntyre, who, despite never earning more than $40,000 per year, own two mortgage-free homes, have put their kids through college, and are comfortably retired with nearly $2 million in savings. They were able to achieve all this by paying themselves first and making their financial plan automatic.
The idea is simple: before you pay your bills, buy groceries, or spend money on anything else, first set aside a portion of your income for savings. This money should be automatically directed into savings or investment accounts.
I’m a big fan of this approach because it ensures that you’re consistently saving money, reduces the temptation to spend the money you should be saving, and can help you build a substantial nest egg over time. It’s simple, yet powerful.
3. You Don’t Have to Make a Lot to be Rich
This principle emphasizes that wealth accumulation isn’t just about earning a high income; it’s about how you manage, save, and invest the money you do earn.
Bach makes the case that you can achieve financial success as an employee by making smart financial decisions, so if the entrepreneurial path isn’t for you, “you can still get rich being an employee.”
4. Make Your Financial Plan Automatic
Another key principle is that financial success is not about willpower but about setting up automatic systems that make managing money effortless.
“Making your financial plan automatic is the one step that virtually guarantees that you won’t fail financially,” Bach writes. You’ll never forget a payment again, and you’ll never be tempted to skimp on savings because you won’t even see the money going directly from your paycheck to your savings accounts. It also frees up valuable time and allows you to focus on the fun parts of life.
5. Reduce Debt
Bach introduces the ‘DOLP’ (Done On Last Payment) system as a method to reduce debt. The DOLP system involves listing all your debts, ordering them from the smallest balance to the largest, and then focusing on paying off the smallest debt first while making minimum payments on the rest. Once the smallest debt is paid off, you move on to the next smallest, and so on.
This method, also known as the ‘snowball method,’ creates a sense of achievement that can motivate you to continue reducing your debts.
6. Homeowners Get Rich; Renters Get Poor
Bach presents homeownership as a compelling strategy for wealth accumulation. He likens it to a ‘forced’ savings plan. Each mortgage payment you make not only covers your living costs but also contributes to your net worth by reducing the principal of your loan. Over time, as your mortgage decreases, the equity—or ownership—in your home increases, effectively building your wealth.
7. Investing
Another key principle is investing. Bach introduces the concept of the investment pyramid, which is based on two principles:
- Your money should be invested in a combination of cash, bonds, and stocks
- The allocation of these assets should change over time as your life situation changes
Bach’s other principles of investing are:
- Set up automatic contributions to your investment accounts to ensure consistent investing and benefit from dollar-cost averaging.
- Understand the exponential growth potential of your investments when the interest earned is reinvested.
- Wealth is built over decades, not days, so maintain a long-term perspective when investing.
Bach recommends using mutual funds to invest in a diversified portfolio of stocks, bonds, or other assets and setting up automatic contributions to your investment accounts.
In the two decades since “The Automatic Millionaire” was first published, Exchange-Traded Funds (ETFs) have emerged as a popular investment option, replacing many mutual funds. I like ETFs over mutual funds because ETFs typically offer lower expense ratios and can be traded like stocks, providing greater flexibility.
ETFs also have lower minimum investments, making them more accessible to investors.
Criticism
While “The Automatic Millionaire” has gotten a lot of praise for its straightforward advice, it has had some criticism over the years as well. Here are a few points of contention and my thoughts.
Some have argued that Bach’s “The Latte Factor” overemphasizes frugality and pushback on this concept, saying that merely saving a few dollars on lattes won’t lead to real wealth accumulation. They suggest that focusing on generating income or on larger cost-saving areas is more effective.
This topic is very personal; many believe in enjoying their hard-earned money in the present, even if it means giving up some savings in the future.
Another criticism is that “The Automatic Millionaire” emphasizes homeownership as one of the ways to build wealth. But this view of home ownership as a ‘forced’ savings plan has been criticized for being overly simplistic.
Real estate, like the stock market, experiences ups and downs. But if you’re primary purpose in buying a home is to live there and you plan to stay in your home for a few years, then owning a home typically makes sense.
On the other hand, if you compare the return on investment (ROI) of real estate to other investments, it’s the data clearly shows that stocks have performed much better over the long term.
Final Thoughts
The core theme of “The Automatic Millionaire” is that financial freedom is less about the size of your income and more about how effectively you manage it. If you’re not saving money with your current income, it’s unlikely you will in the future.
I can tell you that my personal experience having worked with over a thousand clients over the years supports this. I’ve seen a lot of people with high incomes who proportionately increase their spending and often find reasons to avoid future savings.
While “The Automatic Millionaire” may appear simplistic, I think the book’s beauty lies in its simplicity. It’s not intended to provide comprehensive advice for your unique situation, but to provide a simple and easy-to-understand blueprint for automating your finances.
By automating your financial plan, you’re eliminating the possibility of human error while making sure you’re making consistent progress toward your goals.
Regardless of your income level, if most people put into practice the key principles in “The Automatic Millionaire,” they’ll likely be better off financially in the long run.
