A few years ago, I read this book called “Obvious Adams.” It’s a business book about this fictional character, Obvious Adams…
He’s not sexy. He’s not “cool.” He doesn’t have any “ninja business skills,” but he’s one of the best advertising men in the world simply because he sees the obvious and acts on it. Anyway, it reminded me of something in the world of finance that always baffled me. Many a financial goo roo recommends a method of paying off debt called “the debt snowball.”
Basically, the way it works is you start with your smallest debt, make extra payments on it (while still paying the minimum payment on all your other debts) until it’s paid off. Then, you move onto your next largest debt, and so on.
Sounds fun, right?
The reason it’s supposed to work is because it gives you “quick wins.” You see the small debt paid off…which motivates you to keep going. I’ll admit…there is a strong psychological advantage to this method. You see those debts fall like dominoes, and it just feels good. Nevermind you’re paying through the nose on the rest of your debts…
…which is why it’s so much more expensive to do it.
If you have a debt of $1,000 @ 0%, $5,000 @ 5% and $50,000 @ 12%, which do you think is costing you more money?
Pretty obvious right?
But…the debt snowball method will have you spinning your wheels with the $1,000 and $5,000 while you continually get hammered by the interest on the $50,000. Oh math. We have a love-hate relationship with you. Check it: if you start with the highest INTEREST rate debt first, you will pay the least amount of interest. Every. Single Time. It’s mathematically guaranteed.
It’s kinda-sorta common sense, too.
When you start with the most expensive thing…you end up saving yourself all that expense. When you start with the smallest debt balance, you end up futzing around for years and…you do eventually get everything paid off…but you also end up wasting a lot of time and money.
Now, the alleged defenders of the debt snowball method will argue that the psychological benefits of starting with the smallest balance debt first is strong. So strong, it’s worth doing… and that it helps keep people motivated to pay off their debts.
In some cases, maybe that’s true. But, these same gew-ruse also argue that you should get out of debt ASAP and that paying interest is (essentially) evil, which is interesting since… they explicitly advocate a method of debt repayment which keeps people in debt longer than the simpler method of paying the highest interest rate debt first. I’ve run this scenario time and again, and there is only one time when the debt snowball makes sense — and it only works temporarily and for a very specific purpose: when you need more cash flow to get started.
Lemme ‘splain. Let’s say you have very little, or maybe no extra money to put against your debts. Or, maybe you have a small savings that could pay off a $1,000 credit card that’s costing you $50 per month.
In that case, maybe you should just pay off the grand — it gives you something to work with.
…but then, switch to the highest interest rate method…it gets you out of debt faster and costs less.
This is because with each payment on that $50,000, your minimum payments go down (assuming it’s a credit card-type debt). And…you can put more and more and more against that debt…and your payments keep dropping like a stone until…
…it’s all gone.
Getting out of debt is 1% information and 99% psychology. Seriously. It’s technically very easy to get out of debt.
Volumes and volumes of information have been written about it…but it’s all a waste of paper and bytes. Here’s the big secret: start small, and continue to repay your debts until they’re all gone.
BOOM. That’s it. Miracle of miracles, revealed!
Anyway, I figure people are gonna do what people are gonna do.
Most people don’t use the high interest rate method. They go for the “quick win” method…which tends to come ‘round and bite them in the booty later. I think it’s funny that some financial goo-ruse still sell this idea of “the quick win.” Maybe this sounds “too obvious” but… that’s how people got into trouble in the first place (credit cards give people a “quick win” by letting them spending money they don’t have).
Reinforcing the same psychological behaviors to get out of debt just seems…I dunno…dumb.
I get it. Behavioral finance says it’s much easier to get people to stick with something when there’s a clear emotional payoff. That’s why the debt snowball “works.” But, it’s also really expensive way to pay down debt. Real positive change often doesn’t come from doing what’s comfortable or easy though. How do you change human behavior? Baby steps. Most people are short-term thinkers, and they won’t change…
…which means you can take advantage of them easily enough…sell them high-priced “financial peace” seminars, home study courses, budgeting systems, and a near-endless series of books that tell you exactly what I just told you in this free blog post (though in a much longer, drawn out, way).
If you happen to be struggling right now…and you’re frustrated with all the short-term, quick-win, bite-you-in-the-booty methods that litter the Interwebs, you might be interested in my financial planning service.
There are no ninja tricks. No shortcuts. No snowballing. And, not only do I not cover “quick win” stuff… I cover long-term (often slow-but steady) savings strategies that take time to pan out…but always work. And, work like gangbusters. The weird part is…it’s all basic and “obvious” stuff…stuff almost everyone overlooks.
If so, jump on my email list and learn more about my “wicked” ways.