One of the principal strategies of personal finance given by financial entertainers is the idea of the debt snowball.
The gist of the idea is that you pay off your smallest loans first, which will help you divert the cash flow that would have otherwise been spent on that smallest loan to the next biggest loan. This process continues until all of your debt is gone. As the focus is on the size of the debt, and not the interest rate on the debt, it allows for a sense of momentum to be built and for debt to be paid off in the most efficient way.
This is the correct approach, but it’s not a snowball. The metaphor is used, I suppose, because it’s the only example they could think of that implied the sense of momentum that this style of debt management produces.
But let’s take a look at what is really happening with this debt repayment process. There is a sense of momentum, but it is not the momentum of accumulation, it is the momentum of unwinding. As each of the smallest debt is repaid, the total loan balance shrinks, and the speed at which the next loan is repaid increases. This is a laudable goal and a great way to accomplish debt repayment. But there’s no accumulation happening. There’s no snowball growing.
A more apt description is that this debt repayment process is akin to a roll of toilet paper. If you start pulling, initially each square of toilet paper only turns the roll a portion of a rotation. The more squares that are pulled, the faster the roll spins per square of toilet paper, and this increases until you get to the end and there’s nothing left, just like in debt repayment.
It’s a more appropriate metaphor, not just because it actually matches what’s happening mathematically, but because…. well, after you’re done cleaning up the mess you’ve made with your debt, you’ve got nothing left to show for it.
Does this matter? You may think it’s just semantics, that the process is the same, regardless of how you define or describe it, so it is useless to point out the difference.
But the fact is there does exist a way to start a financial snowball in your life. It’s not through debt repayment (though it can help with that) and it’s not through investments (though it can help with that too). It’s through a process (the Infinite Banking Concept) of building capital in a financial asset that accumulates with guaranteed uninterrupted compound interest for the rest of your life. A financial asset, that like a snowball rolling down a hill, never stops and never diminishes.
And here’s the reason it’s important to draw this distinction. The people who promote the toilet-paper-roll debt idea simultaneously tell you that starting a capital snowball is a bad financial idea. They call it the ‘worst place to put your money’ or a ‘scam,’ when in fact it should be the first place you put your money.
Their idea of paying cash for everything is equivalent to starting a snowball down a hill, but stopping it just as it is starting to gain momentum, trudging back up the hill and starting with a new snowball. The better idea is to build the biggest snowball you can, start it down the hill and let it go.
The best part is if you do it right, you can use the value of your growing capital snowball without ever stopping it’s descent. To find out how, contact me here.