Switch - Chip Heath [54]
One of Ramsey’s best-known and most controversial debt-fighting techniques is the “Debt Snowball.” When the Farrars found themselves with over $100,000 in debt (not including their mortgage), they started working on the Debt Snowball. The first step was to list all their debts—everything from credit cards to overdue electric bills to student loans—and then arrange them in order from smallest to largest. Next, their instructions were to make only the minimum payments on every debt, with one exception: After the minimum payments were made, every available dollar would be put toward the first debt on the list. Because the first debt was the smallest one, it could be paid off relatively quickly, and the Farrars could cross it off the list and then direct every available dollar to paying off the second debt, then the third, then the fourth. As they crossed off each debt, they were able to eliminate a minimum payment, which gave them more cash to attack the next debt. That’s why the strategy is called a Debt Snowball. With each debt that is conquered, the “snowball” of money applied to the next debt grows and rolls a little faster.
Notice what’s missing here: any mention of interest rates. If the Farrars’ smallest debt was a past-due utility bill, with no interest charges whatsoever, Ramsey still advised them to pay it off before tackling any of their credit card bills, which might have interest rates of 20 percent or above.
This advice makes the average financial adviser cringe. After all, simple math tells us that we’re financially better-off if we pay down high-interest debt first. But Ramsey knows exactly what he’s doing:
Being a certified nerd, I always used to start with making the math work. I have learned that the math does need to work, but sometimes motivation is more important than math. This is one of those times…. Face it, if you go on a diet and lose weight the first week, you will stay on that diet. If you go on a diet and gain weight or go six weeks with no visible progress, you will quit. When training salespeople, I try to get them a sale or two quickly because that fires them up. When you start the Debt Snowball and in the first few days pay off a couple of little debts, trust me, it lights your fire. I don’t care if you have a master’s degree in psychology; you need quick wins to get fired up. And getting fired up is super-important.
Most financial advisers recommend that their clients pay down high-interest debt first in order to optimize the impact of their money. But Ramsey’s not trying to solve an optimization problem; he’s trying to solve an Elephant problem. The reason people get themselves into financial trouble, he knows, is that they lose control. They begin to feel powerless in the face of a mountain of debt. And you can’t combat powerlessness with math. You combat it by proving to people that they can win. If you pay $185 toward a $20,000 debt on a high-interest credit card, you’re still going to feel hopeless. But if you completely pay off a $185 overdue utility bill, you can cross it off your list. You’ve won a victory over debt.
Ramsey is using the same strategy as the Fly Lady with her 5-Minute Room Rescue—if people are facing a daunting task, and their instinct is to avoid it, you’ve got to break down the task. Shrink the change. Make the change small enough that they can’t help but score a victory. Once people clean a single room, or pay off a single debt, their dread starts to dissipate, and their progress begins to snowball.
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How Can You Cut the Budget Without Creating a Political Mess?
SITUATION Mary Carr is the CFO of a university that is experiencing significant drops in enrollment. With fewer students, the university’s tuition revenue is declining, leading to a budget shortfall. Carr’s job is to oversee meaningful budget cuts across about thirty different departments. [This was a real situation.]
WHAT’S THE SWITCH AND WHAT’S HOLDING IT BACK? Carr needs the heads of the university’s departments to cut departmental budgets without lots