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There are more methods for paying off debt than I could list in a single article, but my personal favorite and the one I recommend the most is the “Debt Snowball”. The best way to manage debt is to avoid it entirely, but if you’re like almost 80% of Americans, you’re already in it pretty deep and trying to figure a way out. Recessions and inflation really magnify this problem, there are more searches for “debt management”, “debt elimination” and “get out of debt” than I’ve seen since the 2002 recession.   

Get that snowball rolling down the hill! I know that sounds silly now, but just keep reading. I’ve seen people that have struggled with their debt for years turn their lives around pretty quickly with this method. Before we dive into the details let me tell you what makes this approach different and more powerful than other methods you may have tried in the past. 

The Debt Snowball provides rewards along the way, and these rewards encourage you to continue paying off your debt. The other major benefit of this approach is that it instills good money management and saving habits without you even realizing it. By the time your debt is gone, you’ll be a disciplined wealth-building machine.

Here’s how it works. First, create a list of all of your debts. A table similar to the following is all you’ll need…

Notice that these are sorted in ascending order by the amount owed with the smallest balance first and the biggest balance last. Why? Because that’s the order you’ll be paying off your debt, that’s how the snowball works. Paying off the small debts first gets the snowball rolling down the hill. We’re not going to worry about the rate or the minimum payment, we’re just going to focus on balances. I also added a row where we could list how much extra you can afford to pay each month in the “Pay extra if you can row”, $100 in this example.

To get your snowball rolling, you want to pay the minimum payment on every debt except the smallest. That’s right, it might sound like blasphemy based on all of the debt elimination methods you’ve tried in the past but I’ll say it again, just pay the minimum on every balance except the smallest. On your smallest debt, Macy’s in our example, you will pay the minimum plus whatever extra you can afford.

You must also STOP BORROWING for this to work. Until you’ve made substantial progress, no more loans and no more financing. Pay cash or use your debit card if the inconvenience of cash annoys you, but don’t borrow or charge ANYTHING.

Back to our example. The first month we are going to pay the minimum payment of $40 for Macy’s plus the extra $100 that we can afford. We will pay the minimum payment on everything else.

Fast forward two months…

Two months later and we’ve already eliminated the Macy’s card, a great start. So now that Macy’s is paid, what do we do with that $40 minimum payment? We packed it back on to our snowball so that it can get bigger as it rolls down the hill. My metaphors are usually pretty weak, what I’m literally saying is that we took the $100 extra and the $40 minimum Macy’s payment and started applying it to the Bank of America card which is why you already see a much smaller balance.

Let’s fast forward two months again…

Now the Bank of America Card is paid! How could it be paid off so fast? We paid the minimum $27 payment plus we applied all of our extra money. Extra money? We are still paying $1,134 in payments each month, that total “Payments per Month” amount is never going to change. When a debt gets paid off, we simply add its payment to the next smallest balance and we keep doing this until everything is paid off.

Paying off these smaller debts is like taking baby steps, it’s a great reward and it doesn’t take very long plus it reinforces the behavior. Can’t you see yourself being pumped after you closed out that Macy’s card and then even more excited when you paid off Bank of America only two months later? Wouldn’t that give you motivation to continue? For many people, the answer is yes, they can see real and fast progress.

Let’s fast forward six months this time…

 Another debt paid off, Nieman Marcus is gone! We are now applying $446 per month to the American Express bill so it is disappearing quickly (the $100 extra + $40 Macy’s payment + $27 Bank of America payment + $180 Nieman Marcus Payment + $99 minimum American Express Payment).

Usually after this many months, paying the $1,134 no longer seems like a burden, it starts to feel like a reward and a victory. You can really see yourself chipping away at that mountain of debt because you are starting to make BIG payments on your smallest balance.

Let’s jump ahead another 6 months…

Great progress, we paid out the Chase AND the American Express.  At this point, only the biggest ugliest debts are left, all the small stuff is gone. Since we continue to pay $1,134 per month even though a lot of our debt is gone, our snowball is starting to turn into an avalanche. This will allow us to take out those big balances quickly, we can apply $592 per month to our Rooms-to-Go account.

We’re going to jump ahead another six months, and this time, pay particular attention to how much debt is disappearing…

See how fast you can pay off even large loans when you use this method? You’re still paying $1,134 per month, but with all of your small debts gone, $692 per month was going to Rooms-to-Go. After Rooms-to-Go was paid for you were able to start paying $999 toward your car payment per month and still pay the minimum payment on the student loan!

This time we’re going to fast forward an entire year, mostly because I’m tired of doing the calculations…

 All of your debts are gone except for a $7,046 student loan balance and it took less than three years. You’ve erased $34,120 of debt. Seven months from now, even that student loan will be paid off since you’re still paying $1,134 per month.  

In addition to getting out of debt, you will have gained something very valuable along the way, the habit of saving. You may be thinking “The habit of saving?! All I’ve only been doing is paying off debt, I haven’t saved a dime!” 

That’s the beauty of the Snowball Approach, you continued to pay $1,134 per month even though debts were disappearing. You could have taken that extra money and spent it, but instead, you chose to live beneath your means and apply the extra money to debt. When all of your debt is gone, what will you do with that $1,134 per month? That’s right, save it! It will be easy, it won’t even feel like saving because you’re already in the habit and you won’t miss the money because you haven’t had access to it in three years.

I’m a firm believer in long-term goals so let’s skip ahead to the happy ending. Say you decide to save that $1,134 every month since you’re already used to living without it. What will you have after 10 years if you save $1,134 per month in a tax deferred 401k and get the S&P average return of 10.75%?  $242,539.  How about after 20 years?  $949,784.  What if your employer offers a $3,000 401k match during that 20 years? $1,159,172.

Enough reading, get to it, go make your list and throw your first Snowball! 

Best of luck and please add your thoughts to this post, we’ll all benefit from your questions and insights.
~ Odd

For some reason, when I woke up this morning, I couldn’t stop thinking about the principles that drive people, particularly those related to personal finance and investing. It’s fascinating to me that there are so many different approaches that can all wind up leading to the same place, prosperity. That is the goal for most of us, right? I don’t really think of wealth in terms of acquiring assets. For me, the goal of long-term wealth building is an overall state of abundance, security, and happiness and I think that’s probably true for many people.

When an idea gets its hooks in me I have to get it out of my head onto paper or I won’t be able to concentrate on anything else, so today let’s talk about The Basic Principles of Personal Finance and Investing.

Anyone that is serious about managing their money well and planning for the future has a set of principles that guide their behavior. This doesn’t mean that they carry around a list that they refer to every time they’re about to make a purchase or an investment. In fact, most successful long-term wealth builders would probably have trouble putting their personal finance and investing principles into words.

Some wealth builders follow a set of beliefs and behaviors that are so ingrained and that they’ve been adhering to for so long that they no longer have to think about them. For this lucky group of people, building wealth comes as naturally as breathing. At the opposite end of the spectrum are those that actually keep a list. Usually the list consists of personal finance and investing wisdom that they’ve accumulated over the years and that they review on occasion to make sure they’re still on track. These examples are extreme, most wealth builders fall somewhere in between. You have to be pretty anal to keep an updated list of your investing and personal finance principles… and yes, I have a list. I guess if I’m confessing I might as well admit the whole truth, I actually have TWO lists.

I thought that today I would share my lists in the hopes that you will add a few of your own principles or expand on mine in the comment section. Below are the 10 Investing Principles and 10 Personal Finance Principles that I adhere to. These lists aren’t meant to contain every important concept, only those principles that I feel are critical to success. I wanted to keep this post relatively short, so every item on the list is a link to an article that will give you a much more detailed description. If you want to discuss any particular principle or if you want to add ideas, please post here rather than on one of the link pages so that everyone can benefit from your insight.

Since I spend a lot of time giving financial and investing advice my list is pretty dynamic, I constantly review and refine it. On rare occasion, when I run across something new and interesting, I add to it.

Odd’s 10 Basic Principles of Investing

• Start Right Now: When you have money to invest, put it to work. Don’t wait for the perfect moment or the perfect stock because they may never come.
• Diversify: A fancy way to say don’t put all your eggs in one basket. If you diversify properly across several asset types, industries and geographies, you can lower risk AND improve returns at the same time.
• Dollar-Cost Averaging: Invest a fixed amount of money on a regular basis. This helps you form the habit of investing, lowers your cost basis, and helps you avoid the buying-high and selling-low syndrome common to beginning investors.
• Manage Expenses: Don’t let transaction costs, mutual fund fees, taxes and investing advice expenses eat up your earnings. This is particularly important for people with smaller portfolios, these expenses can take a big chunk out of your returns.
• Compare to an Appropriate Benchmark: Regardless of your goals or strategy, you should always compare your performance to a benchmark. That’s the easiest way to determine how well you’re implementing your strategy and whether or not you’re improving as an investor. Watch the indexes that track the types of securities that you invest in, and if you can’t beat ‘em, join’ em by becoming an Index Investor.
• Be Diligent: During long bullish periods, many investors tend to get overconfident and complacent. They stop learning about investing, stop adjusting their strategy, begin ignoring risk management principles, and lose touch with the current market and economic conditions. Diligence is your vaccine.
• Investor Psychology, Don’t Follow the Herd: It seems that most investors are willing to follow each other up mountains and off cliffs simply because that’s what everyone else is doing. Control your psychological impulses. Follow your strategy, don’t follow the herd.
• Keep it Simple, Invest in What You Know: Warren Buffet pushes new investors to stick to simpler strategies that are easier to master and Peter Lynch encourages investors to learn a great deal about an investment before risking any money. These are two of the most successful investors of all time. I trust them, and you should too. This is great advice for those of us that don’t have the time to learn complicated methods of research and analysis or read financial reports as thick as a phone book.
• Don’t Throw Good Money After Bad: Many investors tend to ride losers down because they hate taking a loss and because they’re always sure it’s “about to turn around”. These same investors also frequently take a profit too quickly out of fear that a stock can’t go up any further. Don’t throw good money after bad, hold on to your winners as long as they still meet your “buy” criteria and sell your losers when they don’t.
• Choose One Strategy and Work Hard to Master It: When you combine strategies with different (often opposing) goals and selection criteria, you are virtually guaranteed to trail the market. Really, that bad? Yes, that bad. Over 80% of professional fund managers and investing advisors lag the S&P 500. You have to excel to beat the indexes and to excel you have to master your strategy.

Odd’s 10 Basic Principles of Personal Finance

• Live Beneath Your Means: Regardless of your income, you should always strive to spend considerably less than you make. Form good habits that will help reinforce this behavior like paying cash, sleeping on large purchases, and paying off your entire credit card balance every month.
• Make Your Money Work for You, Invest It: Money stuffed in the mattress or stashed in a low-yield savings account will just get moldy and die a slow horrible inflation death. Invest your money so that it can grow.
• Preserve Your Capital: This principle follows “Make Your Money Work for You, Invest It” for good reason. There’s a big difference between gamblers and investors, make sure you’re the latter. This is your nest egg, you will need it for retirement. You won’t get a mulligan if you lose a lot of money on a stupid gamble.
• Personal Finance is More Than Numbers: People tend to associate personal finance with numbers but many personal finance mistakes are emotional, not numerical. Do you have the discipline to save every month? Can you master your impulse purchase urges? Will you stick with your investing strategy through good markets and bad? These are emotional, not mathematical, barriers to building wealth. Work as hard on your financial and investing discipline as you work on understanding and implementing each principle.
• Save at least 15% of Your Gross Income: I bumped the old 10% rule of thumb up to 15%. Why? Planning for retirement falls squarely in the individual’s lap today, people don’t get near as much help as they used to. Pensions are nearly extinct and social security may begin to shrink in the near future. In addition, stock market volatility has been much higher than the historical norm ever since the tech boom of the 90’s, and the 15% gives you a much needed cushion.
• Own, Don’t Rent: For anyone planning to live somewhere for two or more years, there is no worse way to spend money than to throw it away on rent. Rent isn’t tax deductible and every day in an apartment is a day you could have been earning equity. If you’re a first time home buyer, there has never been a better opportunity to buy than right now. Don’t interpret this as encouragement to splurge, rule #1 is still important. Buy much less house than you can afford.
• Take Advantage of Free Money: There are a lot of free money opportunities out there, take advantage of them. One of the best is the 401k Match which ranges from $2,500 to $5,000 at many companies. This dollar for dollar savings match is a free and instant 100% return on your money. IRAs and Roth IRAs are also great opportunities, they provide free money in the form of tax breaks and tax free investing. Mail in rebates, going to the library for books and movies, the list is basically neverending. Please post your favorite free money idea in the comment section below so we can all take advantage.
• Avoid Debt: Carrying a lot of debt is a sure way to add stress to your life and delay retirement. Wouldn’t you rather enjoy your money then send it to banks and credit card companie