Tuesday, May 20, 2014

Household Debt: One Small Victory At A Time

In both financial and economic theory, debt repayment is most effective when the highest cost debt is tackled first, i.e. pay off the debt that has the highest interest rate. That’s the rational solution, as it reduces the burden of debt the fastest.

But this abstracts from the very human desire and motivation to reduce debt. From that perspective, reducing the smallest debt burdens is actually the most effective strategy. And here’s the proof (abstract):

Small Victories: Creating Intrinsic Motivation in Savings and Debt Reduction
Alexander L. Brown, Joanna N. Lahey

Saving when faced with the immediate option to spend is an unpleasant but not conceptually difficult task. One popular approach contradicts traditional economic theory by suggesting that people in debt should pay off their debts from smallest size to largest regardless of interest rate, to realize quick motivational gains from eliminating debts. We more broadly define this idea as “small victories” and discuss, model, and empirically examine alternative behavioral theories that might explain it. Using a laboratory computer task, we test the validity of these predictions by breaking down this approach into component parts and examining their efficacy. Consistent with the idea of small victories, we find that when a mildly unpleasant task is broken down into parts of unequal size, subjects complete these parts faster when they are arranged in ascending order (i.e, from smallest to largest) rather than descending order (i.e., from largest to smallest). Yet when subjects are given the choice over three different orderings, subjects choose the ascending ordering least often. Given the magnitude of our results, we briefly discuss the possible efficacy of these alternative methods in actual debt repayment scenarios.

Quick wins, low-hanging fruit, small victories – whatever way you want to call it, making progress however small is a necessary part of any process. At the risk of over-generalising, breaking up difficult tasks into small, achievable segments increases the rate of success. Taking it even further, any success however minor should be celebrated, because these are just milestones to greater achievement.

The human mind works in wonderfully strange and mysterious ways.

Technical Notes

Alexander L. Brown, Joanna N. Lahey, "Small Victories: Creating Intrinsic Motivation in Savings and Debt Reduction", NBER Working Paper No. 20125, May 2014


  1. how would you define small debts, most households have a car loan, house loan and credit card debt. some may have personal loans. which one first if using this model as a premise?

    1. usually in terms of debt value

      non banks loan (eg Court FlexiCredit, smartphone contracts) < credit card < personal loan < car loan < house loan

      so the point is settle the non bank loans first like if you bought a TV or blender at Court via installment, settle that first, and that small victory will give you motivation to kaotim the bigger loans.

      this strategy makes sense esp for credit card, the interest payment usually starts low and manageable. but if you don't settle it quickly and you dont watch what you (or ur gf/wife lol) spend, it balloons to hell in no time.