The Compounding Effect of Small Leaks

Settling the argument in the personal finance space around coffee and how it can be a microcosm for other aspects of your life.

February 22, 2021 | 4 minute read

If you have a friend who is really into personal finance, ask them if they buy coffee from Starbucks. It will trigger them.

They’ll say something like, “No, never buy coffee from Starbucks. Save your money, invest it, and you’ll be rich when you retire.” Or, they’ll fall on the other end of the argument: “Buy what ever coffee you want! Saving $3 on a coffee, even compounded over 30 years, isn’t going to make a big difference in your wealth. Instead, focus on increasing your salary and saving on big ticket items.”

So which is true?

Small Leaks

Poker players have this concept called a leak: a blind spot that causes you to consistently make an error. As an example, a very common rookie leak is to only raise (put in more money) when you have a good hand. You can see why this would be problematic: after a few rounds, an observant opponent will be able to tell when you have a good hand and when you don’t.

In an individual round, a small leak affects your chances of winning or losing. But a leak, even a small one, becomes devastating as it compounds over the course of a game.

It’s the psychological equivalent of a leaky faucet. At a slow rate of 1 drop per second, a literal small leak can lead to thousands of gallons of wasted water per year. All without anyone noticing.

Money Leaks

So should you buy coffee at Starbucks?

Well, in the game of personal finance, buying extra coffee you don’t need every day is a small leak.

Spending $3-5 on a coffee on it’s own isn’t much. But do so every day and you end up spending $90 to $150 per month, or $1,080 to $1,800 per year. If instead, as the argument goes, you invested that $90 to $150 in an index fund at an average return of 8%, in 30 years it would contribute somewhere between $135,000 and $225,000 to your investment portfolio. That is enough for 2-5 years of your retirement.

So money leaks — but, does it matter?

If you increased your salary today by $12,000 and invested the after-tax income (about $700) to the same index fund, in 30 years it would contribute $1,050,000 to your portfolio. If you lived off of that sum it would last you ten to twenty years. Or, you could keep it invested and live off of the interest indefinitely.

So clearly the coffee is a distraction, right?

The reality is that both sides are correct, but incompletely so.

Starbucks is a Symbol

The side of the argument that says to ignore leaks in your money, like coffee, miss a really important point: leaks beget more leaks.

There’s no question that getting an extra coffee is a small leak. But what starts as a $5 coffee on your walk to work can quickly become lunch out, with a drink or a side, and/or ordering dinner out instead of cooking what’s in your fridge. Yes, the first leak was only $3. But that leak grew throughout the day and now its $80 ($5 for coffee, $15 for lunch, $50 for dinner, plus $10 to have it delivered).

The same psychology that lead to the first leak can not only lead to more leaks, it can lead to much larger leaks. The extra coffee can quickly turn in to extra features on your new car or a house with more square footage than you need.

How much do those things cost? Thousands of dollars? Tens of thousands of dollars?

So the real value of saying, “Don’t buy coffee” isn’t the $3-5 per day or the ~$200,000 in 30 years, it’s the compound effect of coffee, take-out, an afternoon cookie, and one more pair of shoes all the way up to buying a house that’s bigger and more expensive than you need and getting the extra features added to your car.

“Don’t buy coffee” is a symbol. It will have an affect on your overall wealth on its own, albeit a small one. The real gain in sealing this leak will be that you won’t allow others to open.

The Power of Small Things

Leaks don’t just happen with money. They can happen with anything, including your time.

Do an experiment where you track your screen time on your phone, laptop, and any other devices you own. I guarantee you’ll be astonished by how much time is lost once you add up all the small leaks: Twitter, Instagram, Netflix, Reddit, etc.

As is characteristic of all leaks, these things don’t consume that much time individually. Taking five minutes to scroll through Instagram, on its own, is just five minutes. But how much is it when you add all these little leaks up at the end of the week?

Take Netflix, for instance: the average American watches four hours of TV each night. That’s 28 hours per week (3.5 work days) and 1,428 hours per year —almost 36 work weeks per year.

If you have ambitions to start a company, write a novel, learn to cook, paint, or sing, but can’t quite find the time, look for leaks.

Play Both Sides

By closing up a leak in their game, a poker player decreases the odds that they’ll lose. But fixing a leak won’t change their odds of winning. In order to do that, they need to play each hand strategically.

So it is with any sport or game. In American Football, the defense’s strategy isn’t to stop the other team’s offense before they tackle the quarter back. It’s to not let the offense through the line at all. In Basketball, the defense isn’t trying to block the other team from shooting. They’re trying to keep the other team from ever getting close to the net.

You won’t get rich saving $3 on coffee but you also won’t get rich if you let yourself spend what ever you want, even if you try to make up for it by earning more.

The problem isn’t that offense or defense is better than the other, it’s that you need to play both well in order to win. Not just with your money, but with everything.