Today I will be discussing the principle of “keeping on, keeping on” and how it applies in the realm of personal finance, specifically debt. We all know that some goals require one big push to get them completed, while others require a consistent application of effort. In personal finance, the vast majority, be it, paying down debt or saving for a down payment on a home, require consistent application over relatively long periods of time.
This last week here on Mzansi Finance has been really quiet, because I have made a conscious effort to get my New Year’s goals going. (You can see my goals/resolutions here). This has necessitated that I take some of the time that I spend on the blog and direct it to other pursuits temporarily, until I build up some momentum in those areas.
My technique of choice is called “Front End Loading”. This involves doing as much as I can in a short period of time, until I get back into the swing of things. One example from my list of goals would be “learning Chinese”. What I have done for the last week is learning as many characters as I can and listening to all my recordings from last year, until I find that I can recall words and phrases more easily again. This makes it much easier to take in new material as the lessons continue.
I like the “Front End Load” technique, because it uses my strength (“sprinting” towards a goal) to build momentum for the part that I am not good at (the “marathon” part), which involves putting one foot in front of the other and just staying the course.
In personal finance, putting “one foot in front of the other” is the only way to pay down debt or save for other big goals, such as retirement or for a down payment on a home. Trying to do these as quickly as possible, is generally not feasible, because it involves large sums of money that most of us just don’t have laying around.
This momentum-building is why the “debt snowball” is so effective. The “debt snowball” involves ordering your debts from smallest to largest and then throwing as much money as possible at the smallest debt, while paying only the minimum on the rest. Once that goal is paid off, you pay as much as you can to the next-highest balance and pay the minimum on the rest and continue this way. This goes against economic and finance theory that suggests that it makes more sense to pay off the debt with the highest interest rate first, to save on interest charges.
Many people who are in debt, however, find that the motivation from paying off one of the loans, far outweighs the benefit of saving on interest. Let me explain with an example:
Let’s say, for example, someone has the following list of debts:
Credit card 1: R25,000 at 25% interest
Car loan: R20,000 at 15% interest
Student loan: R12,000 at 12% interest
Credit Card 2: R5,000 at 8% interest
Economic theory says that you should be paying as much as you can at the 1st credit card, while paying the minimums on the rest. This way you will save by paying the highest interest rate for the shortest time. This also means, though, that the Credit card 2 will be paid off last. (1st strategy: highest interest first)
A lot of people find, though, that they stay much more motivated when they pay of Credit card 2, first, because they only have “3 more debts” to pay. This motivation for “having paid of one” keeps people going for much longer on the marathon of paying off the debt, because they can see the progress. (2nd strategy: debt snowball)
In the example, above, if the person used the first strategy, they would finish paying of the big debt first, before having a go at the other 3 debts. If they used the 2nd strategy, they would have 3 debts paid off before they tackle the biggest one. This is a bit like the first competitor having one water break in the marathon, while the second competitor would have had three water breaks already. Who do you think will be fresher to keep on going?
The subject of the best strategies to become debt-free is fascinating and I will be exploring it in other posts here on Mzansi Finance. I hope you found this post informative and helpful.
Kevin Mzansi
Image by lulemon athletica
