The paradox of choice is that the more options we are given for a particular choice, the less likely we are able to make a choice. Penelope Trunk discussed it in her article about taking a job, any job and references Dan Ariely, an MIT behavioral economist, and his book Predictably Irrational. In the book, Ariely discusses a study about how people ended up buying more jam when given six potential samples versus twenty four. Twenty four potential samples was simply too much and people ended up not deciding, even though they had more information.

How does this apply to banks and credit cards? Too much information paralyzes us. It paralyzes me. In the case of jams, there’s no pain in not buying a particular flavor. In the case of credit card debt, there’s a significant pain in not paying down a card. With a bank, there’s a bit of pain in interest not earned and a bit more if you overdraft because you forgot which account held how much (or you forget how much you need to keep in an account to avoid fees because you have too many accounts). Too much information, like juggling many balls, hampers our ability to make good decisions and causes us unnecessary pain.

The solution is the simplify your finances.

If you have credit card debt, pay down the smallest amounts first. This may sound similar to Dave Ramsey’s Snowball technique and that’s because it is. However, rather than focusing on the psychological benefits (yay! another debt conquered! let’s get the next one!), I argue that removing one headache from your life, even if it’s not the most financially distracting one, is beneficial. Next, try to consolidate bigger debts into as few accounts as possible without sacrificing the interest rate. By not sacrificing the interest rate, I mean don’t consolidate lower interest cards to higher interest cards (which sounds obvious but sometimes we make mistakes). The number of credit cards offer zero fee 0% balance transfers are dwindling but they often have a fee transfer cap that could be to your benefit.

With banks, don’t keep accounts you no longer need. I kept an old employer’s credit union account open for a year and a half and it cost me $20. I had transferred money into that account from my Emigrant Direct account and written a check. The check didn’t get cashed for several weeks and before it could be cashed, I went into my account and saw some money sitting around. Not remembering why the funds were there earning a low interest rate, I transferred them back and got dinged with an NSF. While I was able to get the NSF removed, it was entirely my mistake but caused by keeping an account I didn’t need or use anymore. There are no negative credit impacts of closing bank accounts, so close the ones you don’t need anymore and drop juggling that ball.

Simplify your life and reduce the number of things your brain has to manage, you’ll be happier and richer for it.

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On a happier note, my post on the Top 5 Online Banks made it into this week’s Carnival of Personal Finance hosted by Canadian Dream.

“I usually keep my card wrapped in a picture of my children to remind me of why I shouldn’t spend … ”
                                             – Trent of The Simple Dollar

If you think money is about dollar and cents and things you can hold in your house or your hand, you’re wrong. Personal finance may seem like it’s all about the numbers, where you have to spend less than you earn, where you have to save up an emergency fund, where you have to invest in the stock market and get your 10% return; but the truth of the matter is that personal finance is more about psychology than it is about mathematics. Everyone knows that you have to spend less than you earn, no one is so disconnected or so poorly educated that they don’t realize how basic math works. It’s like physical fitness, we all know what we’re supposed to do, we just have difficulty remember to do it.

Trent made the above quoted statement in response to my post about how you should write your goals on your credit cards. My tip was a simple reminder, his was a simple reminder packed with the power of psychology. You can easily write the goal on your credit card and then dismiss it when you need to spend. Dismissing a picture of your children, the reason you live, breathe, and work every single day… dismissing that would take a Herculean effort. But it works. Trent knows he shouldn’t splurge on food or kitchen tools or video games, JD knows he shouldn’t splurge on comic books, and I know I shouldn’t splurge on vacations. Slap a picture on it, of either your kids or your cats, and it drives that point home like a jackhammer.

If you think Dave Ramsey Is Bad At Math, you’re not alone. You’re also right. Dave Ramsey’s Snowball debt busting methodology is mathematically suboptimal. For those unfamiliar with it, you essentially pay off your smaller debt amounts first, then roll those payments into larger and larger debts. The payments “snowball” and you are also rewarded with positive feelings about knocking out the smaller debts. It’s suboptimal because you would save more money by paying off the highest interest rate debts first, but you lose the psychological benefit of kicking one of those debts in the butt. While suboptimal mathematically, for many it is the optimal solution because it helps them overcome their debt. It may not be smart math, but it’s smart psychology.

The next time you have difficulty with something personal finance, be it spending less than you earn or saving towards something, try some psychological tricks and you may find that it works out better in the long run.

Have you ever gone to the mall and impulsively bought something you hadn’t intended? Have you ever gone to the grocery store and walked out with a couple things you didn’t plan on getting? Sure, we all have. I’ve gone to the supermarket for some chicken, eggs, and yogurt only to return with coffee filters and a package of pork ribs because both were on sale (coffee filters are never on sale, probably because a package of 100 only costs $2 anyway and you can conceivably use it for 100 days!). It’s called impulsive buying and here’s a close cousin of it that is very powerful but less often used: impulse saving. Here’s one great way you an impulsively save:

Impulse Saving & Debt Paydown

Get a yourself a six-sided die (or more sides if you prefer) and roll it. Take that number, multiple it by ten, and put it in a savings account or pay down a debt. Do it every single time you get a paycheck and learn to live without the money in your budget.

If you don’t have a die, figure out another way to randomly generate a number. If you truly can’t afford to save up to $60 a month without feeling great pains, multiple the number by $5 so the top impulse saving amount is $30. If you truly can’t afford to save up to $30, you need to re-assess your financial situation, but for that’s a topic for another time.

To facilitate impulse saving, electronically link up your bank accounts or set up electronic bill pay. This lets you quickly and easily save or pay down debt in a handful of clicks. Without electronic means, the transfer of savings or pay down of debt is made less efficient to make smaller transfers and payments.

Why Do This?

Saving money and paying down debt is hard and any little trick you can take advantage of will be to your advantage. I think impulse saving is a lot like snowflaking (an idea and term first coined by PaidTwice, someone please clarify if I have this wrong). With snowflaking you generate more income through various means and put it towards your debt. With impulse saving, you force yourself to spend less of the unplanned “noise” in your budget by “spending” it first on savings or debt. The ideas are close cousins but slightly different in where the funds come from.

So, why should you do this? Because we impulsively buy stuff all the time. No matter how disciplined we are, there is always noise in our budget that we simply cannot account. Rather than fight it, take advantage by spending it before you get the opportunity to spend it. If you impulsively save it first, then you are less likely to impulsively spend it. This won’t prevent you from impulsively spending but if you do, the impulse savings are cutting down your debt. It’s like improving your worst case. (worst case is nothing, you spend but already paid down by that amount; best case is that you pay down debt)

How Good Is This Idea?

Let’s take an example to illustrate how powerful this can be. If you have $8,000 in credit card debt at 19.99%, it would take 11 years and 1 month of $400/mo payments to clear the debt. By paying down an additional $30 a month, (less than the average impulse save of $35, but you get the idea) it takes only 10 years and 2 months, a difference of eleven months. If eleven months doesn’t sound like a lot, remember it’s eleven months of $430 payments, or $4,730! If you combine this idea with some debt consolidation by way of 0% balance transfers or peer-to-peer lending marketplaces, you can do some serious damage to your debt.

So, if you have some debt, consider some impulse saving, it’s the latest thing in debt busting since snowflaking!