Use the “Snowball” Method to Destroy Your Debts and Jump Start Your Investments

If you’ve read Dave Ramsey’s book Total Money Makeover you’re familiar with the snowball method for paying off debt. For those who aren’t, here’s a quick primer:

  • List out all of your debts
  • Order them by amount of debt, the lowest amount first
  • Throw everything you can at paying off that debt, and pay the minimum on everything else
  • Once you knock that debt out, move onto the next, snowballing what you were paying toward the higher-amount debts into knocking out the lower-rate debts even more quickly

An alternate way to do this is to list your debts out by interest rate, tackling the highest rate one first. Doing so will mathematically be the most beneficial, ensuring you pay the least amount of interest as you cut these debts out of your life. Paying off a smaller amount first, though, often has psychological benefits that may help accelerate your progress…but each person’s different. Either way you do it, paying down debt more quickly than the minimum amount of time is almost always a great thing. I say almost always because if you have a zero or extremely low interest rate debt, some would argue that it doesn’t make sense to repay it, and you should invest instead. I’m not here to argue one way or the other today.

If you work better with actual numbers, here’s an example. Let’s say you had the following debt repayments:

  • Card 1: $400 ($16 minimum)
  • Card 2: $1500 ($60 minimum)
  • Card 3: $3500 ($140 minimum)
  • Car Loan: $17000 ($270 payment)
  • Student Loan: $25000 ($280 payment)

As soon as Card 1 is paid off you’d allocate whatever you were paying toward it each month to Card 2, bumping the total up. Rinse and repeat on Card 3; at a bare minimum, $216. Then move on to your car loan (but seriously, stop buying expensive cars) and your student loans. Once all of your debt is done, you suddenly have an extra $766 of wiggle room in your budget, plus whatever extra you were throwing at it to accelerate the process! Time to celebrate and spend some more, right?! Wrong!

If you’re not careful, you’ll likely end up in the exact same situation you were in, having to go through the whole process over again. One way to help combat this desire to over-spend is to nip it in the bud by transitioning your budget allocation of debt repayment to saving and then investing, and automate it.

As soon as you’re done repaying debts, you should bolster your emergency fund as soon as you can to make sure that if you lose your job or have another emergency you don’t need to rely on credit cards. Having extra cash in the bank is definitely a comforting feeling, and having the savings automated will help you be less inclined to spend it.

If you aren’t keen on actually investing the money after that – maybe you’re not sure what your next goals are, or they’re too short-term to be reasonably invested – then at a bare minimum moving it automatically to a targeted savings account is another good bet. Having a random savings account that’s not designated for anything can lead to the temptation to mindlessly spend that money. Giving that money a specific purpose, though – like a down payment for a house – will help you achieve those goals more quickly without succumbing to lifestyle inflation or blowing it on useless stuff. It sometimes helps to physically give your account a nickname – lots of banks will let you do this – so that you know every time you see that money what it’s going toward.

After you have a healthy emergency fund and either don’t have anything else short-term to save for, or have hit your goals, the next logical step will be to invest in something that will yield some return on your money. Most brokerage or other types of investment companies (like P2P Lending) will allow you set up automatic monthly transfers. Some will automatically invest the money for you if you want, which is a great way to just let everything go on auto-pilot.

Over time as your income grows, make sure to keep up with adjusting your automatic transfers. Doing so will keep you on target and keep your investments growing in pace with – or faster than – your income, and should remove the itch to spend “extra” money.

Question:

What sorts of psychological tricks do you use to make sure you save and invest money?

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