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You’ve probably heard of the “snowball method”—the personal finance theory that if you pay off your smallest debt first, you’ll feel empowered to pay the rest quickly.However, new research from University of Michigan’s Ross School of Business professor Scott Rick suggests this isn’t the smartest idea, especially when the small debt is one among many and carries the lowest interest rate.
Think about it: If you have an outstanding debt with a whopping APR, you’re going to want to get rid of that first.
Making minimum payments won’t make a real difference and as interest fees pile up, you’ll find yourself in worse shape than you were when you started.
In his study, “Winning the Battle but Losing the War: The Psychology of Debt Management,” Rick found that despite how obvious this is, most consumers ignore this advice as they want a “quick win” and are biased to “non-optimal behaviour.” In other words, they’re primed to spend (stay in debt) and seek instant gratification (spend and delay debt payments).
While paying off the small debt appears like a win, in reality it’s only one piece of the puzzle and a way to BS themselves about how much they’ve accomplished.
As the holidays get into full swing, consumers will be dealing with debt more than ever. Rick estimates the average consumer carries an average balance of more than $1,000—so it’s without a doubt that retail holidays like Black Friday and Cyber Monday will only compound the problem.
But Rick’s research proves consumers need to get real about why they’re spending and how they plan to tackle their debt. Taking any old advice, like that of personal finance guru Dave Ramsey, who was cited in the study, might not always be right for you.
To get on track, we recommend reading how one writer devised a plan that suited her needs and long-term goals.