No, I’m not talking about The Snowball: Warren Buffett and the Business of Life, I’m talking about the other snowball, the debt snowball. The debt snowball is a great method when reducing your debt quickly.
I have heard this term (debt snowball) knocked around many times in the personal finance realm, and I was curious to find out exactly what debt snowball meant.
I felt even more curious to find out about how the debt snowball method works after I read that article by Wealthsimple called Debt: A Love Story. In case you haven’t read it, it is about a couple sharing their raw feelings and emotions in their current financial situation.
It was, to be honest, a very painful read because there was a real disconnect between the husband and wife and their reaction to their current situation. The wife seemed like she was in pure distress and the husband seemed a bit oblivious to the direness of the situation. I hope that Wealthsimple provided some financial support/ advice/ coaching for them after that interview.
According to Wikipedia, the Debt Snowball Method involves paying the accounts with the smallest balances first and then making the minimum payments on the larger debts. This is compared to the other often used term in the personal finance realm, the Debt Avalanche Method. The Debt Avalanche Method is whereby you pay the highest interest debts first (e.g. the most expensive debt) and work your way backwards.
Why the Debt Snowball Probably Works
I suppose the debt snowball works well because it knocks out the smallest debts first so that you feel more confident about your debt pay down, reducing your debt quickly- leaving you with more desire and drive to pay down the other debt.
It is probably more expensive than the Debt Avalanche Method because you are working with the smallest debts rather than more expensive debts.
However, even though the math doesn’t make sense, Business Insider found in research done by Harvard Business Review confirming that the Debt Snowball works, that:
the biggest impact on how hard participants worked wasn’t the amount they were paying back or how much was left in the account afterward, it was the percentage of the balance they ended up getting rid of.
It’s motivating to see balances disappear and will make you work harder. Humans are like that. Even when I have a task list, I break it down to smaller tasks to feel better about myself. Or I choose the easier stuff to work on first so that I can just cross stuff off my list, and again, feel better about myself before I tackle the more difficult stuff on my to-do list.
When I see my mortgage balance disappear faster (as the amortization schedule is knocked off- most of your payments go to interest the first few years at least), it makes me feel better, because I know that more of my home is owned by me and not the bank.
Augmenting The Debt Snowball
In addition to using the debt snowball method, it would be quicker to eliminate debt if these steps were added to your debt reduction plan:
Budget (Reverse or Regular)
I personally don’t budget, but I do reverse budgeting. I calculate what I need to set aside every two weeks when I get paid (to pay the mortgage, to pay the maintenance fees, to pay into my joint accounts, and to pay the credit card bill if it’s due) and then I move the money out of my chequing after that. I do create a yearly budget or estimate my set expenses on a monthly basis.
However, everyone is different and budgeting can work excellent for others. Reverse budgeting or regular budgeting can be part of your money managing mindset. You can start off by going through what you’ve been spending over the last few months by tracking them down or writing them down.
There are some excellent apps that will link to your bank account and categorize everything for you- for example, I use Mint.com. Once you know what you’re spending on, you can start making decisions on what you can cut. You can also use an app like “You Need a Budget” YNAB which many people in the personal finance world rave about. I tried it once many moons ago but I am still a stickler for my paper and pen, the old fashioned way.
Calculate Snowball Debt
I found a handy Snowball Debt Calculator on Calculators.org which shows you how much time and money you would save using the debt snowball method. It shows you the number of payments remaining, which is super helpful for motivation and debt pay down, especially when the number of payments gets smaller and smaller when you pick the smallest debt you owe to eliminate first.
Savings versus Debt Pay Down
Many people choose to save even though they have high-interest debt that they would benefit from paying down first. If you have high-interest debt (like credit card interest), it’s hard to have an investment beat a ‘return’ like that (well except for 2017 when the S&P500 did amazing, with a 21.7% return). To put this into perspective, in 2018 (at the time of writing, beginning of December), the S&P500 was down 1.52%.
Therefore, I would advocate for just focusing on debt pay down.
If savings and investing are important, a small portion can be allocated to investing so you can continue to add to your investments with whatever you were paying towards your debt- and change the debt snowball to the investing snowball, the one that Warren Buffett refers to in The Snowball!
I’m always the type to opt for moderation so that way you can work on both goals, so getting the best of both works (investing and debt payoff) makes sense. That way you wouldn’t feel like you’re missing out on investment returns and gains while you are paying down debt.
Have you tried the debt snowball method?
What methods do you recommend for reducing your debt quickly?
GYM is a 40 something millennial writing about personal finance since 2009 and interested in achieving financial freedom through disciplined saving, dividend and ETF investing, and living a minimalist lifestyle. Before you go, check out my recommendations page of financial tools I use to save and invest money. Don’t forget to subscribe for a free dividend yield spreadsheet and the free Young Money Bootcamp PDF.