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.)
**This article is featured in the Yakezie Carnival: Spring Training Edition**
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We agree that the advice of Dave Ramsey leaves some to be desired, but for different reasons.
I believe that it is more important to build your savings than it is to eliminate debt with the same money. I am not saying that it is not important to eliminate debt, just that it is not as important as building your savings.
I wrote a book on the subject back in 2005 when I taught personal financial management at a local college and have been coaching the process ever since and even wrote a second on just that subject, alone.
Suzy Orman has finally come around to my way of thinking and even put out a special alert to the readers of her blog to say so.
As a Dave Ramsey fan, Dave-trained finance coach and former “debt snowball” user … I thoroughly enjoyed this post!
Sure, it’s fun to poke at Dave and call out differences in approach to paying off debt. I think he’d be 100% with you on the spirit of this though. It’s all about getting out of these ridiculous debts!
Your bucket of hot water is a great plan. I’ve seen the snowball work too. Let’s just get rid of the debt!
Quick story: I’m working with a family paying off about $80k in credit cards and a car. They’re the “math” type and we actually started using your “hot bucket of water” approach without knowing the name. Put the extra cash and the highest interest payments. This past month, they looked up and had $6k extra to put on debt (extra paycheck month). They were all set to throw it on the 18% card ($17k balance) but realized they could also payoff their car loan with that money.
Don’t get me wrong, I’ve been through Dave’s Counselor Training Program and would still choose to do the debt snowball (go ahead, call be brainwashed). But we were attacking that high interest payment up until this month. In the end the couple decided to payoff the car… on their own. I can’t even describe the enthusiasm in the voice as they started thinking about paying off the car. It was a little peek at freedom for them. I’m convinced these little wins are absolutely crucial for many people!
Keep up the excellent content here and making people think for themselves. If we blindly follow what Dave or Suzy or you or I say, we’re no better than those morons in DC!
This article was great! You know I have to partially agree with Ramsey in regards to the psychological aspect of debt. Many “experts” will tell you not to put off saving in a 401k even if you do have lots of credit card debt etc., some of that is because of tax savings and emloyer contributions, but also because some people dont have the discipline to pay down debt,..eventually time passes and they need retirement savings, even if it’s just a little.
However, I really liked how you pointed out that paying the highest interest payment is far more important than the highest rate! Im so tired of seeing the same regurgitated advice on blogs and personal finance columns in the newpaper about how you should pay down the cards with the highest rates first. If your balance is significantly higher on another card, you could be paying more in interest! Such a good point!
http://www.moneyistheroot.com
I happen to think you both are right. And I am not being wishy-washy.
The math and science geek in me agrees with you.
All the psychology courses, and my 30 years experience in working with people tell me some just have to have little wins to keep momentum. Otherwise they crash and burn…
I would like to learn more about your approach.
Cool calculator. I’ve heard of the snowball method, and I always thought the same thing. Why not pay off the small balances first?
He says that the plan doesn’t exactly fit everyone but gives you something to go by. I don’t follow exactly as he says but my way is helping me better.
Thanks for the insightful comments, everyone. (Don’t forget to keep qualifying for the contest, which is still in effect until Saturday.)
Dave Ramsey preaches that consumer debt is bad, and that’s that. I don’t think it’s quite that simple, but if I had to tell readers to either embrace consumer debt unequivocally or shun it with zero tolerance, I’d have to pick the latter.
If you’re disciplined enough to use credit intelligently, making yourself a zero-revenue customer and letting the credit card companies worry about how to make money off their other cardholders, you can have the credit card companies dancing to your tune instead of the other way around.
The best way to handle the debt snowball is to not be in the position of having to consider the debt snowball in the first place. That might sound simplistic, and of dubious value to people who are already in debt, but it’s true.
But if you are in debt, the smoking analogy always seems to work. They found a malignant tumor in your lung, and Ramsey’s advocating smoking low-tar cigarettes and stretching out each pack…instead of telling you to just throw away your last Marlboro 100 and live with the withdrawals, no matter how acute the short-term pain is.
Maybe this goes without saying but one thing I’d do if I had the first debt list is I’d pay off the Best Buy with equil payments from now till December. Many of those 0% deals charge the interest on remaining amout retroactive to the purchase date if not paid off. So to make the math simple from March till Dec pay $130 toward the Best Buy and make sure it’s closed out before Jan 2012!
Anything unsecured just default on it. F em. Then never finance anything again.
“However, I really liked how you pointed out that paying the highest interest payment is far more important than the highest rate! Im so tired of seeing the same regurgitated advice on blogs and personal finance columns in the newpaper about how you should pay down the cards with the highest rates first. If your balance is significantly higher on another card, you could be paying more in interest! Such a good point!”
This premise, which is also used in the article, is mathematically incorrect. It is, in fact, the interest rate that should dictate payment priority if the goal is to pay the least amount of interest. Often this will also be the debt that has the highest interest payment (as in the example in the article), but that may not be the case if one balance is much larger than the others (as the quote mentions). Mathematically, the highest priority should be placed on the highest interest rate.
Your advice would suggest that people should pay additional to their mortgage (or any large consumer debt) at 5% before paying a smaller credit card debt at 30%, just because the amount of interest charged monthly is larger. If you can eliminate X dollars of debt you should choose the ones costing you 30 cents each before the ones costing you 5 cents each, even if you have much more of them.
I am also not understanding why you would pay the bill with the highest interest payment rather than the one with the highest interest rate. I assume you are paying the minimum balance required on all debts to avoid penalties (other than interest). All extra payments should then be applied to the balance with the highest RATE, regardless of how much actual interest is owed. If you reduce X amount of debt you will incur less interest if that X amount is applied to the highest rate.
Say for example you switch the APR rates of the car loan and visa card. Now the car loan has the highest APR at 22.7%, and the VISA has the highest balance at 9114.4, but the lowest APR. The discover remains unchanged, but now has the largest interest payment (in real dollars).
For simplicity, lets forget about monthly payments, you just pay by the year, and your minimum payment is $0 for all debts.
VISA : 9114.4 @ 5.9% = $527.75
DISC: 6111.63 @ 17.9% = $1093.98
CAR : 3588.39 @ 22.9 = $821.74
By your logic you should apply all your payment to the discover card since it has the most actual interest payment. If you have $3,000 to pay this year, you can pay the discover card down $3,000, then your situation looks like this:
VISA : 9114.4 @ 5.9% = $527.75
DISC: 6111.63-3000 @ 17.9% = $556.98
CAR : 3588.39 @ 22.9 = $821.74
for a grand total of $1916.47 after interest is applied for the year (you did not get charged interest on that $3000 you paid).
If you apply that to the car loan instead (since it has the highest RATE):
VISA : 9114.4 @ 5.9% = $527.75
DISC: 6111.63 @ 17.9% = $1093.98
CAR : 3588.39-3000 @ 22.9 = $134.74
for a grand total of $1776.47
You still pay a lot of interest on the discover card, but you are saving even more on the high rate loan by paying it down.
You really need to revise this article and any books you have put this advice into. This is just plain bad advice from a mathematical view point.
I think all of you money gurus have it wrong. Paying a debt snowball could render a person exhausted and they may end up debt free but they’ll be broke. What I do is always pay myself first. I call it my CASH SNOWBALL. When I earn money I pay myself most and first — then pay my bills. I watch my savings grow to my delight. It makes me feel empowered..I get smarter with my money and spending so I can see my cash snowball get bigger and bigger. I’m teaching myself how to feel weatlthy and get wealthy. Having that cash snowball has turned my thinking about money totally around. I have paid off all my credit cards..never will ever get another. I don’t waste my money…I’ve learned how to make more in less time. It has been amzing. I suggest you all start your cash snowball. roll on.