That “Debt Snowball” has a rock in it

Worst definition of "snowball"? Dave Ramsey's. 2nd-worst? Urban Dictionary's.

Dave Ramsey is wrong.

Still, the kindly radio host and personal finance author certainly isn’t hurting for devotees. His show is on 450 stations, which is about 449 more than the author achieved at his peak and Ramsey’s books sell a disturbing number of copies. No one seems to have anything too critical to say about him, and dozens if not hundreds of personal finance bloggers treat him like a demigod.

Then there’s us. Sorry to ruin the party, but following Dave Ramsey’s advice can make a bad financial situation worse.

This criticism isn’t personal, like it would be with Ramit Sethi. Ramsey is presumably earnest, and seems pleasant. He believes that the government’s role in the economy isn’t just confiscatory but debilitating, a position we’ll second and third. He incorporates a tinge of Christianity into his financial advice, which serves the dual purpose of reminding readers of the possibility of salvation while irking the uptight few who get offended at the mere thought of religion.

But math is hard for some people, and on first glance Ramsey either doesn’t know that or doesn’t care. (Turns out he doesn’t care, which we’ll get to shortly.) His major contribution to the personal-finance lexicon is the popularization of the “debt snowball”, a term that his readers have taken to heart but that’s as misleading as the phrases “economic stimulus”*, “IRS refund”** and “flat tax”***.

Thousands, maybe millions of people swear by the debt snowball. Here’s how it works, and why it doesn’t:

1. Arrange your outstanding consumer debts in ascending order of balance.
2. Pay the 1st one off in its entirety.
3. Pay the 2nd one off in its entirety.
4. Etc.

Ramsey argues that the psychological high of getting an account down to a zero balance and closing it will inspire you to tackle the next highest debt on the list and eventually the rest.

Here’s an example. Let’s call this debtor “F. Mayweather”.

February 2011 Balance ($) Interest rate (%)
VISA card 8779.41 22.9
Discover card 5934.58 17.9
Car loan 3553.45 5.9
Best Buy bill 1300.00 0 until January 2012,
then 22.9%

F. bought a refrigerator from Best Buy (“36 months no financing!”), a car 4 years ago, and miscellaneous junk with the credit cards. He hasn’t made a payment on the fridge since buying it, but has to pay the whole balance sometime in the next year.

Say F. picks up an extra couple of shifts at the plant nursery and knows he’ll pocket an additional $650 in each of the next 2 months.

By Dave Ramsey’s reckoning, F. should use the extra money to wipe out the Best Buy account. By April he’ll be down to a more manageable 3 debts instead of his previously overwhelming 4.

Yeah, except for this:

April 2011 Balance ($) Interest rate (%)
VISA card 9114.49 22.9
Discover card 6111.63 17.9
Car loan 3588.39 5.9

By shooting the varmint but letting the big game grow bigger, F. has raised his debt by $547.07. He took 1 step forward and 2 steps back.

Here’s the Control Your Cash debt bucket of hot water (the sworn enemy of a snowball. It has fewer steps, too):

1. Put any extra money toward the debt with the highest interest payment (not rate). In this example, the VISA bill has both the highest payment and rate.
2. Sell whatever assets you have handy to drive down and ultimately eliminate those liabilities.

The used-but-still-viable furniture you’ve been holding onto for no apparent reason, the old junker car you could sell for parts, the never-used skis that someone on Craig’s List is itching for – each of those are assets, and each is earning you a 0% return. Apply them to your “anti-investments” that are paying returns of -22.9%, -17.9% and -5.9%, and you can eliminate those financial drags all the faster.

Your assets also include your capacity for work. If your idle time isn’t earning you anything, doing anything that generates revenue (or at least, doesn’t cost you money) will lower your debt more quickly.

You’ve got leverage here, even though you probably can’t see it. Spending a few hours now attacking debt at the roots, rather than the leaves, will eliminate that debt months if not years faster. Leaving you the wherewithal to buy assets that do earn a return.

There’s also a zeroth step to the debt bucket of hot water, which is “Buy our book and avoid incurring these idiotic debts in the first place.”

So why does Ramsey advocate the mathematically unsound debt snowball?

He repeats ad nauseam that if you separate the topic of personal finance into 2 mental components, it’s “80% behavior”. The remainder is what Ramsey dubs “head knowledge”, presumably distinct from elbow knowledge or pancreas knowledge.

In other words, according to Ramsey, doing something is 4 times as important as knowing what to do.

Is that true? The sentiment might sound good, and there are any number of fortune cookies and self-help authors willing to echo it, but what about its merits? Here are conflicting schools of thought from 2 titans of 20th century American marine warfare:

Admiral James Stockdale: “Leadership over academics.”
Admiral Hyman Rickover: “You’ve got to know what you’re doing.”

Count us in the camp of the Father of the Nuclear Navy. (That’s Rickover, which you should have learned in school.)

While we focus on personal finance on this site, the subject intertwines so tightly with personal development that sometimes a little of the latter can’t help but slip in. Knowing what to do – Ramsey’s “head knowledge” – is the inevitable first step. Following through on it – behavior – has to come second. Not only that, that behavior is up to you. Which we can’t really help you with, from our vantage point separated from you by time and distance.

Briefly changing to first-person – I mean that. I’m writing the first draft of these words at 11:45 pm GMT on January 10 in Honokowai, Hawai’i. When they find their way to you, you’ll be in a later time and a different place. I don’t know where you are, nor when you’re reading this, nor even what you look like. You wouldn’t know where I am, nor when I wrote this, if I hadn’t told you. But the validity of the content remains the same, and we don’t need to be face-to-face for it to be valid. Do action A and avoid action B if you want to achieve a particular goal – in this case, getting your consumer debt up to 0. Or if you prefer, just absorb the “head knowledge” and do something else. It won’t work, but at least you can say you didn’t try.

*forced private property transfer on a national scale
**interest-free loan from you to the federal government
***diagonal tax (see Chapter 9,
Control Your Cash: Making Money Make Sense)

(Thanks to Napoleon McCallum, USNA ’86, for the admiral quotes.)

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