The Economist vs. The Snowball

Popular financial advice guru Dave Ramsey has long advocated for what he calls the “debt snowball” approach to repaying debt for financially stressed households: order your debts by amount, smallest to largest, and repay them in order, ignoring interest rates. This sounds decidedly unscientific, and from a classical economics perspective it is bad advice. Rational actors should settle debts with highest interest rates first, regardless of the size of debt, in order to minimize the total amount they will have paid when all debts are finally settled. But, argues the snowball, if the debt never gets paid off at all because the debtor is daunted to the point of paralysis by the prospect of paying off a huge debt, then the classical advice is irrelevant.

new NBER working paper by two researchers at Texas A&M University provides experimental evidence from the lab that supports the intuition behind the snowball approach. The researchers randomly assigned the order in which participants had to complete tasks varying in length, and those who had to complete their tasks in order from shortest to longest finished their entire list more quickly. The authors hypothesize that initial “small victories” can help individuals to build motivation for later tasks.  They write, “In relation to debt-reduction, this principle suggests there may be an additional motivational benefit for a person paying off his or her smallest debt first, and then paying the rest of his or her debts from smallest to largest.” Translated into Dave Ramsey’s pop motivational lingo, “you need some quick wins in order to stay pumped enough to get out of debt completely.”

One potential problem with interpreting these findings in the context of debt repayment is that the task in the study was abstracted from any actual financial decision.  The people in the study were asked to enter short and long strings of words into a computer, not pay back their credit card debt.  So it’s not obvious that behavioral insights gained from what maximizes efficiency in this task should be generalized to prescriptions for financial management, but the authors do cite some non-experimental work that supports this leap: in a 2012 study of 6,000 debtors, people who went with the snowball approach were more likely to pay off their debt in full, accounting for debt size.

A few more drawbacks: In the Texas A&M study, when participants were allowed to choose the order of their tasks, they chose the efficiency-maximizing order least frequently.  And it seems that those who reaped the most benefit from shortest to longest task order were those with the highest self-control and reasoning abilities, leading the authors to suggest that the snowball approach may benefit least those whom one might a priori believe would benefit most from a rule-of-thumb approach to repayment. Finally, the sample size was small—only 91 subjects. 

But the initial results are tantalizing, and there is certainly room for more work to be done in both the lab and field to understand how to create motivation to complete tasks such as debt repayment.