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Did September even happen this year? I think I missed it. The only thing I remember about last month is that the Bank of Canada raised interest rates again. It’s always stressful when the amount of interest on your debt increases. It feels like you’re […]
I no longer have any credit card debt. I have an emergency fund. I’m paying down my six figure student loan debt and increasing my net worth at a decent pace.
Even though I’ve made massive changes, you would never know it from my thoughts or activities.
I still check my accounts multiple times a day. I still have trouble sleeping the night before payday. I still spend the majority of my money as soon as it’s deposited, although now it’s mostly used to pay off debt.
I’m still living in the paycheck to paycheck cycle.
I feel like I’m on a financial roller coaster, and that the ride never stops. If you’ve ever had an unhealthy relationship with money (or anything else), you’ll know what I mean. When payday rolls around, a euphoric rush hits you as you crest the top of a peak. You hover there for a moment before your stomach drops out as you plummet back down. Money seems to evaporate in a glut of spending, and the distance to the next payday stretches out in front of you before you begin the slow, rickety climb back up.
Is saving money always positive?
I know my financial situation has drastically improved this year and I don’t want it to seem like I’m not grateful for my advantages or pleased with my progress. This obsessive behavior is beneficial to me in many ways – I’ve paid off a substantial amount of debt, been diligently saving for retirement, and reined in my impulse spending.
My net worth keeps going up, but what about my self worth? I do generally feel proud of myself for finally taking control of my finances, and for making so much progress this year. At the same time, the underlying feelings of inadequacy are stronger than ever. I wrote about all of the comparison that happens in the financial independence community recently, and I was absolutely including myself in that category. Starting out with six figures of student loan debt has instilled this sense of always being behind and trying to catch up. I’ve read amazing stories about early retirees around my age that were able to finish working before I really even started. Avoiding these comparisons altogether would be ideal, but unrealistic to ask of my very human brain.
Will this feeling ever go away?
If I’m being honest, probably not! I think achieving debt free status will add some much needed stability to my financial situation, but I’m not so naive to think that my relationship with money will be ever be completely healthy.
Aside from the fact that I have chronic imposter syndrome and nothing I do seems to alleviate it, unstable emotions around money are tough to avoid. I can’t just quit currency. At the very least, I need to earn and spend regularly to buy shelter and food to survive. I can’t save up a certain amount and let it sit predictably in a savings account either, because keeping up with inflation requires growth and growth brings volatility. A time will come when the swings in my investment accounts will be gains or losses of thousands of dollars rather than hundreds. I already have to be careful not to check my accounts too often, and I only have about 2% of my retirement target saved!
How do I find balance?
I know what I theoretically should be doing to find balance, but I’m struggling with the execution. I could be meditating or doing breathing exercises or writing affirmations or starting new hobbies. I could be doing any number of other things, but it seems like I’d rather be obsessing about money.
It’s so easy to open the spreadsheets or web browsers and recalculate my debt free date, or my retirement date, or my net worth. I can login and check my accounts and investment balances with a few keystrokes. Even if I’m away from the computer I could probably tell you the numbers by memory. I’m just not a ‘set it and forget it’ type of person.
Acknowledging my feelings is a great first step, but I need to focus on getting off of this roller coaster ride if I want to be financially and mentally successful with money.
Do you obsess about personal finance too?
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If you think your finances are entirely ruled by careful consideration and freewill, riddle me this: Why does consumer research show the exact opposite? Why do marketing budgets show the exact opposite? Why are lenders making serious cash hand over fist? The emotions behind spending […]
Despite what many personal finance experts will tell you, there is no debt repayment method that fits every situation for every person. The ‘do whatever works best for you’ model isn’t going to sell any books though..
I’m not a personal finance expert, so I’m free to share my honest opinion of the two most common debt repayment methods, the debt avalanche and the debt snowball, and suggest an alternative that I think brings out the benefits of both.
Is anyone else bored stiff with the snow metaphors? I think it’s time to crank up the heat with the debt bonfire! Let’s visualize!
Imagine that you’re on a beach. The sun is setting and you’re building up a fire. You’ve got a pile of wood next to the fire pit – your debt. You start small at first, building up a base and preparing the kindling. You light the small pieces and even though you’re just getting started, you begin to feel the heat. You keep adding bigger sticks and then logs, one by one, and the fire grows. Eventually you’ve built it up so that the flames are licking the sky. You watch your wood pile dwindle as you add each piece. Eventually you set the last log onto the fire and break into a triumphant grin. The final things you toss in are your loan documents and you watch them shrivel up and burn to ash, viking funeral celebration style.
Now that got me fired up more than the image of snow sliding down a hill.
Order your debts from highest to lowest interest rate, and tackle the one with the highest interest rate first.
The debt avalanche will save you money over the course of your repayment, but only if you stick to the plan. If you lose motivation, even for a short time, you can completely wipe out any gains you’ve achieved by choosing this method rather than a more psychologically efficient one. Use with extreme caution, and only if you have the willpower equivalent of an obedient robot with a passion for mathematics.
Order your debts from smallest to largest amount, and tackle the one with the smaller amount first.
Support for the debt snowball method abounds, from Dave Ramsey‘s decades of success stories to research from the Harvard Business Review and the American Marketing Association’s Journal of Marketing Research. If you’re a squishy sack of habits and urges like me, this method will give you the psychological boost you need to stay the course and kick your debt to the curb. One disadvantage is that it doesn’t take into account other motivating factors like the urge to ditch ultra high interest debt, or to save face at home by paying back a personal loan to a family member.
Order your debts from most to least motivating, and tackle the one that you find motivating first.
Instead of finding a suggested plan and following it, I recommend creating your own plan. This way, you can have the structure of a plan but in a customized way that will keep your motivation bonfire burning right down to the coals.
Which Debt Payoff Method Is Right For You?
I prefer the hybrid method of the debt bonfire, because I want to utilize every available method and take advantage of the best aspects of each one. If you find yourself making exceptions to the debt snowball or debt avalanche method, maybe it’s time to admit that you should be creating your own plan too!
Let’s say that these are your debts:
- $3,000 / 20% / credit card / bank
- $25,000 / 5% / student loan / government
- $2,000 / 0% / personal loan / family
Using a repayment calculator with a monthly budget of $1,000, you’ll find that the debt snowball and debt avalanche method resulted in the same debt free date, and that the difference in interest was only $358 over the 34 month payoff timeline.
If you happen to get discouraged using the debt avalanche method and stop paying more than the minimums for a few months, say goodbye to some of that extra cash and potentially your debt free date too! I’ll happily pay $10/month more in interest as insurance on my debt free date.
That being said, if the $25,000 student loan happened to be at a 10% interest rate, the debt avalanche method would save you one month and $695 in interest. Maybe you’d be more motivated to pay off a higher balance first at that rate.
Individual considerations for your debt free journey:
- interest rate
- payment history
- type of debt
- cash flow
- legal consequences
Let’s look at the example above again. What kind of considerations might these three debts bring?
- $3,000 / 20% / credit card / bank – high interest rate, emotions from overspending on credit, unsecured debt
- $25,000 / 5% / student loan / government – medium interest rate, high amount, socially ‘acceptable’ debt
- $2,000 / 0% / personal loan / family – low interest rate, low amount, relationships, emotions from borrowing from a family member
What if, above all, you hate your credit card because the interest rate is insane and it constantly brings up feelings of shame for overspending? You might start following the debt avalanche method because of this preference for paying a high interest debt first.
What if you then felt guilty for borrowing money from a family member, but it’s at 0% interest and therefore last in the prescribed order? You might decide to follow the debt snowball method to clear this one before your student loan.
What if I told you that you could do both?
Using the debt bonfire method, you order your debts from most to least motivating.
- $3,000 / 20% / credit card / bank
- $2,000 / 0% / personal loan / family
- $25,000 / 5% / student loan / government
Now you’re free to tackle your debts in the order that will fuel your motivation and encourage you to stick with the program for the entire debt repayment timeline. As you pay off one debt, the thought of paying off the other debts will become more motivating because you’re also getting the psychological benefits of completing an item on your list.
This method has the added bonus of not making you feel like you’re cheating on the process. There can be a lot of guilt associated with making ‘exceptions’ to the debt snowball or debt avalanche methods. Questioning yourself on the method can lead to losing motivation and potentially delaying your debt free date. If you include these ‘exceptions’ in your plan from the beginning, there’s no guilt! In fact, there’s another motivational boost from following your goals as outlined.
If math is your ultimate motivator, and you can honestly say that you will stick to your debt repayment plan, go with paying the highest interest rate debts first.
If relationships are the most important to you, and getting that loan from your grandmother off of your conscience will get you fired up, pay that one first.
If you owe money to the government and could potentially go to jail if you don’t pay it, maybe start there.
Are you following the debt snowball or debt avalanche, or did you make up your own method like the debt bonfire?
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I may lose my personal finance membership card for this, but I think math needs to be smacked right off its lofty pedestal. I know the personal finance community is full of optimizers and math evangelists, but please bear with me. You can judge me in the comments later.
Math is not the perfect, rational response to every personal finance question. Just because we’re dealing with numerical values doesn’t mean that they have to be rigorously and exclusively applied.
One of the reasons I think we use math to make decisions is that it’s relatively simple, in a big picture way – it’s input and output. It’s predictable, tangible, and universal. Math can be used to shut down a conversation, because how can you argue with ‘$10,000 > $5,000, the end’?
Math is the easy way out, and it’s far from the whole story. When it comes to personal finance and other issues with a human element, math is only part of the equation. If the information we use is quantified in amounts of money, interest rates, investment yields, and savings percentages, what’s missing?
I don’t know, how about the entire range of human emotion?
Consider these common personal finance questions:
- Is it better to make higher student loan payments or invest?
- Should I pay off my mortgage early?
- Do I settle a personal loan with a family member, or pay off my car?
The math favors paying off high interest debt and prioritizing investing over paying low-interest debt. The problem with this approach is that it does not take several major factors into account:
Many of the mathematical calculations for determining whether to pay debt or invest assume a certain percentage of returns, but the reality is that there are no guarantees in the investment world. Our normalcy bias causes us to believe that things will continue to function in the way that they have in the past.
To accurately weigh two choices, we need to seriously consider events like a market downturn, job loss, or other financial crisis. The additional money we’ve made by investing could be wiped out if we were forced to withdraw a portion of our portfolio in a down market.
We just saw the same biased behavior only a decade ago in the 2008 financial crisis, when we were gambling on the housing market, convinced that it would only go up for infinity.
When the tide goes out, you can tell who’s been skinny dipping. – Dave Ramsey
In a long bull market, confidence is at a high and we tend to discount the potential effects of a future bear market. What happens when the tide turns and you’re overleveraged?
As much as we’d like to think that we’re rational beings, we can still be easily swayed by our feelings. Advertisers know this, psychologists know this, behavioral economists know this. It’s time that we leveraged their research to benefit ourselves!
The standard investment advice is to buy and hold. If we objectively know this, why are there countless questions about timing the market on every personal finance forum?
I’ve heard that you’re not supposed to time the market, but everyone is talking about an imminent crash. Should I wait until it goes down to invest? – Everyone Always
I don’t know about you, but to me that sounds suspiciously like trying to time the f*cking market. We rationally know the answer, yet we ask these questions anyway because we irrationally perceive our own circumstances to be unique.
Why, if math tells us one thing, do we consistently do completely opposite things?
I’d like to introduce you to a little phenomenon I like to call the black box of human emotion.
A black box is a system which can be viewed in terms of input and output, without any knowledge of the internal processing. The human brain is the ultimate black box. We are constantly doing irrational things, no matter how rational we might perceive ourselves to be. In fact, perceiving ourselves as rational when we tend to act irrationally, is irrational in itself!
There are so many examples of irrational human choices that I’d have to start a new blog just to talk about them all. In the meantime, here are just a few examples of the mathematically inefficient choices we make with money:
- loss aversion could explain why we buy things we don’t want, and why we fail to return unused things after we’ve purchased them
- anchoring suggests an appropriate cost of something, even though a rational price might be much lower
- hyperbolic discounting refers to our tendency to choose the smaller immediate gratifications over larger long-term rewards
For some additional reading on the subject, and many more examples of our flawed human mind, check out the books Predictably Irrational: The Hidden Forces That Shape Our Decisions by Dan Ariely, or Thinking, Fast and Slow by Daniel Kahneman.
The math only works to its full extent if we complete a number of transactions perfectly over a number of years. Are we perfect? Science says no.
There’s something inherently motivating about paying a debt off, especially a small one. The rational strategy is to tackle the high-interest debts first, but getting out of debt is actually more likely to happen using the snowball approach – paying debts from smallest to largest amounts.
A team of Kellogg School researchers has found that people with large credit-card balances are more likely to pay down their entire debt if they focus first on paying off the cards with the smallest balances — even if that approach doesn’t make the best economic sense. – The ‘snowball approach’ to debt, news article by Ray Boyer; research by assistant professors of marketing David Gal and Blakeley McShane.
The motivation factor is why Dave Ramsey’s baby steps are so incredibly successful for so many people, despite being mathematically inefficient – someone pays off a small debt, gets a quick win, and feels a push to keep going.
If our motivation stumbles and we spend a portion of the amount we should have been investing, we slowly eat away at the financial benefit, potentially even losing it altogether. Staying motivated throughout the process is key, and it’s more difficult than we think. We assume that our financial knowledge will insulate us, but this assumption is often biased as well.
Humans are notoriously bad at self-control, regardless of our knowledge, so we need all the help we can get. Ever wonder why you see so many doctors and lawyers and finance majors in poor financial health, despite a higher intelligence or financial experience? They’re human!
In the area of financial decision-making, self-control issues are significant (e.g. Raab et al. 2011; Rick et al. 2008) and can plague even the most financially literate (Brown, Chua and Camerer, 2009. – Small Victories: Creating Intrinsic Motivation in Task Completion and Debt Repayment by Alexander Brown and Joanna Lahey.
So willpower isn’t very effective, and more knowledge doesn’t help us? It’s not looking good for you, math!
If our net worth was the ultimate consideration, why aren’t we all living in a van drinking meal replacement shakes? Why do we make accommodations in the math for things like a home and delicious food, but not for our mental health?
Chronic stress caused by volatile finances or a high debt load can start to interfere with your life in major ways. Stress can lead to fatigue, inability to concentrate, irritability, or even physical ailments. For a risk-averse, debt-averse person, owing hundreds of thousands of dollars while investing in an unpredictable market can take a particularly high mental and physical toll.
If we’re so concerned about being financially healthy, why are we not more concerned about our mental (and physical) condition too? Can’t enjoy our fat portfolio to the full extent if we’re in poor health as a result of worrying about it for decades!
We are not perfect. We are emotional and irrational, and pretending that we aren’t can actually be detrimental. Instead of worshipping at the altar of math, we should be considering psychological efficiency as well as mathematical efficiency.
If you’re choosing to pay down your mortgage instead of invest, or pay back a personal loan from family before tackling your other debt, know that there is science behind your choices. Just because math provides a concrete answer, doesn’t mean it’s the correct one. We shouldn’t be so quick to discount mathematically inefficient choices – they could very well be the best option!
Are you Team Psychology or Team Math?