Globally, consumer debt is measured in the trillions of dollars, with U.S. credit card debt alone amounting to approximately $1 trillion. Furthermore, U.S. residents, on average, hold five credit cards each. How best to reduce and eliminate debt is therefore an important question for consumers. The popular American personal finance guru Dave Ramsey advocates an approach to eliminating debt that involves paying off small debt balances before larger ones because he believes that paying off the smaller balances can motivate a person to subsequently pay off the larger balances. Ramsey terms this approach the “snowball method.” Ramsey is not alone in this view, with advocacy of this approach common among consumer financial advisors.
However, objectively, the size of the account balance consumers pay off first should not affect their likelihood of reducing or eliminating their debt. Rather, consumers should focus on paying off higher interest balances first regardless of the size of the account balance (after making minimum payments on all accounts to avoid penalties and surcharges). This approach is thus advocated by the U.S. government.
The authors obtained a highly unique data set that enabled them to examine this question on a time horizon measured in years with real-world behavior and high stakes consequences for the people concerned. In particular, they obtained data from a leading U.S. debt settlement company that enabled them to examine whether closing debt accounts predicts whether consumers succeed in eliminating their debts independent of the size of the closed account balances. That is, is closing a greater number of outstanding balances predictive of debt elimination regardless of the size of the closed account balances?
The authors find that closing debt accounts—independent of the dollar balances of the closed accounts—predicted successful debt elimination at any point in the debt settlement program. Indeed, the fraction of debt accounts paid off appeared to be a more powerful predictor of whether the person eliminated his or her debts than the fraction of the total dollar debt paid off, despite the latter being a relatively more objective measure of progress toward the debt elimination goal.
In addition to specific implications for debt management, these findings are likely to bear relevance to a broader set of contexts. One such context is weight management, for which the findings suggest that people could increase their motivation to attain an overall weight loss goal by setting and achieving more modest interim goals. Another context for which the findings might be applicable is that of frequency rewards programs, such as frequent flyer programs offered by airlines. According to the current study’s findings, a possibility airlines might consider is to provide customers with interim goals (e.g., in which customers receive modest rewards, such as a free meal) to keep them motivated to persist in the program so as to obtain the ultimate reward (i.e., a free flight).
David Gal is Assistant Professor of Marketing in the Kellogg School of Management at Northwestern University. He received his PhD in Business Administration from the Graduate School of Business at Stanford University. Dr. Gal studies consumer motivation and decision making and has published his work in several leading journals, including Journal of Consumer Research, Journal of Marketing, Journal of Marketing Research, Judgment and Decision Making, Social Psychological and Personality Science, and Psychological Science.
Blakeley B. McShane is Assistant Professor of Marketing in the Kellogg School of Management at Northwestern University. In his research, he seeks to develop statistical methodology to accommodate the rich and varied data structures encountered in applied marketing problems and to use these methods to glean insight into consumer behavior. He has applied these techniques to problems in Internet advertising, sleep science, paleoclimatology, law, baseball, and other fields. Before joining the Kellogg School, Professor McShane earned his PhD in Statistics from the Wharton School at the University of Pennsylvania.Journal of Marketing Research, Volume 49, Number 4, August 2012
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