Now, just to set things straight at the outset, we’re talking about a debt snowball here, not the kind made by Hostess.  Many personal finance gurus have variations of the debt snowball; I prefer Dave Ramsey’s as written in The Total Money Makeover.  In the last post, I discussed how debt is not a tool to become wealthy, an assertion backed up by lots of empirical evidence gathered by Thomas Stanley in The Millionaire Next Door.

Problem is, the average American is in debt, and not just a little bit!

So, let’s work out a plan to get you out of debt.  Before we can talk about where to put your money to become wealthy, we have to free that money up from creditors.  Once you are out of debt, then we can talk about 401ks, Roth IRAs and real estate investing.  The Debt Snowball is at once simple in definition and difficult in execution (will power required).  It is not a get-rich-quick scheme.  It will not get you out of debt overnight.  It will, most likely, require some changes to your lifestyle.  It is difficult, but it works.

Brain versus Heart

There are two approaches to the debt snowball: the math-based and the emotion-based.  For the math based approach, list all of your debts in order of highest interest rate to lowest.  Pay the minimum on all debts except for the one with the highest interest.  Put all the money you possibly can towards this debt (highest interest).  Once you have paid that one off, roll your payments into the bill with the next highest interest rate.  Keep doing this until all your debts are paid off!

Do you see where the term “debt snowball” comes from? You start with a small snowball: the payments toward your first bill.  Then, once it’s paid off, you roll that payment into the next, then the next, and your snowball (payment) grows and grows!

Most of Us Are Humans, Not Robots

The other approach, what I call the emotion-based one, has you list your debts in order of smallest amount owed to largest.  You then start the snowball by focusing on the smallest amount and working up to finish with the largest.

The math-based approach, in theory, will get your debts paid off the quickest.  Notice that I said in theory.  Dave advocates an emotion-based approach to the debt snowball, not because the math adds up better, but because it takes advantage of the non-rational human heart.  Here’s what he says:

The reason we list smallest to largest is to have some quick wins…Face it, if you go on a diet and lose weight in the first week, you will stay on that diet.  If you go on a diet and gain weight or go six weeks without any 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.

I think Dave makes a pretty strong point here.  A few easy wins boosts a person’s confidence and gives them the drive to keep going when it gets tough.  This is why I recommend the emotion-based debt snowball.  List your debts from smallest to largest, pay the minimum on all except the smallest, and conquer your debt!  Then we can get into the exciting stuff: wealth building.

Unless, of course, if you’re a robot.