Monday, March 13, 2017

Trick yourself out of debt!

Trick Yourself Out of Debt

As this tragic story demonstrates, debt can have life-shattering consequences. Seriously, follow that link and read the story. I’ll wait here.

Done? OK, welcome back! Pretty somber stuff, huh?...

For all the talk about money—how to save ithow to manage it, how to invest it, how to pay off your debt, which app is best to help you stick to a budget—there is very, very little talk about the emotional side of money. And that’s a topic that we obviously cannot continue to ignore!

You may have heard of the so-called ‘debt snowball’ method: pay off the debt with the lowest amount owed; once that’s paid off, put that extra money toward the next smallest debt, and so on.

Some people take issue with this, since it’s more productive to put your money toward the debt with the highest interest payment first—the so-called ‘debt avalanche’ method. Advocates of the debt avalanche often fail to understand why people would use the obviously inferior debt snowball method instead.


The answer should be obvious, but I’ve found that numbers seem to obscure or distort the truth as often as they reveal it. The simple answer to why debt snowball works is that it gets people out of debt for the same reason they got into debt in the first place: because of how it feels!
  1. Debt snowball feels good. If you have debt on multiple credit cards, plus student loan debt, plus a car loan, and you’ve just realized that you have over 4 times as much debt as your annual salary, the ensuing feeling of anxiety can be absolutely overwhelming!

    Many people are completely crushed by this realization, sometimes turning to alcohol or drugs to ‘escape’ the reality of their financial situation. As the link above shows, some people are desperate enough to take their own lives! And, since student loan debt cannot be discharged by bankruptcy or other legal means, such extreme actions are understandable.

    Debt snowball turns that emotional state around, giving debtors a sense of financial control and power—often for the first time in their lives!

    Consider a [fictional] person named Robert. “Robert” uses the debt snowball method to attack his $130,000 debt. First, Robert pays off a $2000 credit card debt in six months. That quick ‘win’ helps him to realize, “Hey, I can do this! I can actually defeat this debt!”

    Even though the $2000 debt that Robert just paid off is only a small fraction of his total debt, the feeling that he’s just “won,” that he’s just “beaten” his creditors, can be intoxicating! That feeling energizes Robert, encouraging him to redouble his efforts and tackle his next debt (a $4500 car loan) with renewed zeal!

  2. Debt snowball feels easy. So much of the financial world seems extremely complicated. Variable APRs, small cap vs. large cap stocks, shorting, put options, bonds, dividends, tax-sheltered accounts, whole vs. term life insurance…

    This stuff really isn’t that difficult to understand, once somebody boils it down into plain English for you. Often, the problem is finding somebody who can explain these concepts plainly and simply, but isn’t incentivized to oversimplify or slant the truth in order to make money by leading you to a less-than-ideal choice.

    [*An important aside: This is why you need to pick a ‘fiduciary’ financial advisor. Fiduciary advisors usually charge an upfront fee of a couple hundred dollars. The advantage is that they will help you set up a plan that’s best for YOU, without concern for whether they’re paying for that BMW at your expense. Even though people may balk at the upfront fee, it’s much better for you in the long run.*]

    In contrast to much of the financial world, debt snowball is really simple to grasp, and it isn’t trying to deceive you in order to make big bucks for a financial company or a Porsche-driving Wall Street financier. Combined with a savvy marketing strategy to spread the word about this method, debt snowball is now a well-known and established method of destroying debt.
The bottom line

Even though I ultimately agree with the people who advocate the debt avalanche method instead, I understand that the debt snowball approach is useful for many people because of its emotional sophistication. Debt snowball tricks you into getting just as excited to knock out your debt as you were to get the stuff that put you into debt in the first place!

Essentially, debt snowball turns debt repayment into a game of sorts. And it simultaneously sets up the rules so that you get a couple quick wins to boost your confidence, turning despair into self-assurance.

Here’s the bottom line:
  • Debt avalanche is the best way to knock out your debt ASAP.

  • Debt snowball is the best way to trick yourself into getting started.
Which should I use?

There’s value in both approaches. Debt avalanche has the mathematical advantage; debt snowball has the psychological advantage. So, if you’re struggling with debt, I’d like to propose a hybrid of the two. Let’s call it the ‘debt jump-start.’

The Debt Jump-Start
  • Start off with the debt snowball approach.
    • Identify your smallest debt, and start putting your money into paying that off.
    • Once you get that small ‘win,’ pay off the next smallest debt.
    • Those two successive ‘quick wins’ should help you feel much more excited and in-control. Congratulations! You’ve gotten the necessary psychology boost from the debt snowball method!
  • At this point, reorganize your list so that the highest-interest debt is the first target.
    • Now, start putting your payments toward that high-interest debt. From this point forward, follow the debt avalanche approach.
This ‘debt jump-start’ method combines the best of both worlds! It gives you the confidence to get going (as with debt snowball), then leverages that confidence to help you take on the most mathematically harmful debts (à la debt avalanche).

Ultimately, it doesn’t really matter whether you prefer debt snowball, debt avalanche, or debt jump-start, since any of them will get you on the right track. The only difference is in how fast you arrive, and in how likely you are to stick with it.

Remember that the most important step to take on your debt is to get started in the first place!

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