Social

Balancing Rational Advice With Irrational Brains

I’ve had an interesting conversation on Twitter recently where I was “tweeting” (that’s “talking” for the over-50 crowd) about a research study that indicated when paying off debt, there is no advantage psychologically to paying off the smallest debt first.  Instead, you should apply your funds to the highest interest rate debt.

Of course, paying off the debt with the highest interest rate makes rational sense.  When just doing the math, it always is the better financial decision.  Still, the study suggests that the human brain is wired to pay off the smaller debt first.

This research is directly opposed to what one national talk show host, Dave Ramsey, suggests, which is to pay off your small debt first.  It’s a position I have also held in the past, one which I am rethinking in light of the research. 

Michael Kitces wrote a nicely balance article exploring the rational and irrational sides of this debate.  He writes:

The purpose of this blog post is not to debate whether Rick or Dave is smarter, or even about which is the better approach to debt management. The point is that we have two smart people with some real experience guiding people through debt issues, who seem to have used all of their smarts to come up with two completely opposite conclusions about the “best” way to tackle a serious issue. And the difference between the two ultimately boils down to one single issue: behavior.

It’s an interesting debate.  To read Michael’s full post, click here.

Share Button
Print Friendly, PDF & Email

, ,

4 Responses to Balancing Rational Advice With Irrational Brains

  1. Symon Jagersma January 20, 2011 at 7:28 am #

    Hi all, I can recommend reading the book Switch – How to Change Things When Change Is Hard by Chip Heath and Dan Heath. They confirm this Study.

    Further you can find great Whitepaper on Financial Behavior at http://dnabehavior.com/index.php?option=com_content&view=article&id=183

    Kind regards from the Netherlands.

  2. Verne Goodsell January 20, 2011 at 8:07 am #

    Rick,

    I always enjoy your comments. They reflex a mind searching for the best, while striving to be better.

    Verne

  3. Kathleen January 20, 2011 at 8:19 am #

    You can certainly make a strong case for either approach, and like many other things, the “right” answer is going to be different for different people. It seems to me that, no matter which method you use to pay off debt, one crucial element is being able to see measurable progress. If I can see from month to month that I’m X amount closer to getting rid of this particular debt, or I’m saving Y amount in interest, that’s going to help motivate me to keep going. So maybe part of the financial planner’s role would be to help clients set up a system to track their progress–and to help them celebrate that progress.

  4. Dick Wagner January 20, 2011 at 9:44 am #

    Rick,

    It is a “how high is ‘up'” question reminiscent of Ann Landers’ famous “should toilet paper face in or out?” debates. Their common element is their most important: The individual is paying off debt and gaining control.

    If it works for the individual, it is the best.

    Dick Wagner