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Risk & Behavior

Strategy Versus Tactics: The Role of Debt Elimination in Goal-Setting

A behavioral tool can help investors think deeper about their investing goals

Debt is more than what you owe others, it’s an emotional struggle and a barrier to reaching financial goals, such as enjoying an early and comfortable retirement. So, it makes sense that an effective financial plan includes debt elimination, but many investors might not understand that investing may not be an effective way to manage debt.

Our research took a deeper look at the traditional goal-setting process by asking clients what their investing goals were, and we found that this approach prompted investors to list top-of-mind goals that were not a good reflection of what was truly important to them. What we didn’t expect to find is that some people listed debt-elimination as a top investing goal—a common misconception on how to manage debt. In this post, we discuss why investing isn’t an effective way to manage debt and how a master list of common investing goals may help people direct themselves away from this mistake.

Is it better to invest or pay off debt?

For anyone, eliminating high-interest debt should be priority number one. An investor stands to earn 62 basis points, on average, by paying off a credit card before saving for retirement, according to research by David Blanchett, Morningstar’s head of retirement research. For most Americans, the cost of paying an average interest rate of 14% on their credit card balances outweighs the 4% they can earn on their retirement savings, so eliminating that debt should be an immediate priority, not a long-term aspiration. Some participants in our study, however, initially listed debt elimination as one of their top investing goals. This can easily be written off as a common financial mistake, but advisors can use this admission as insight into a client’s mind.

Is debt elimination their true investing goal?

After looking at a master list of common investing goals, many participants replaced their initial goal of debt elimination with one from the master list—40% listed “to feel secure about my finances now” and 20% chose “to buy a house.” This suggests that the master list of goals seems to nudge investors toward more-efficient investing goals by weeding out common investing mistakes. Using a master list may have the unintended benefit of helping people overcome this confusion and, at the same time, offer hints at an investor’s real financial motivations.

Paying down debt is really just a means to an end for investors, and the master list of goals may help people discover that end. The simple behavioral nudge helped investors focus on why they want to be debt free instead of the daunting red number in their balance sheet.

Research suggests that goals can be more motivating if they reflect a person’s true values and aspirations. The master list of goals helped people get to this deeper level of goal-setting by uncovering the underlying reasons for paying off debt, resulting in goals that can be more encouraging and satisfying.

Using a master list to help investors understand their investing goals

Defining investing goals is really complex. Advisors are competing against behavioral and cognitive biases, both of which may be hiding an investor’s true investing goals. Our research found that using a simple behavioral nudge—a master list—seems to help investors think deeper about their financial motivations and values, allowing advisors to engage in more fruitful conversations with clients. Our experiment with the master list is summed up in a worksheet we created to help advisors begin a goals conversation with their clients.

For more about the behavioral science team’s research on setting and working toward strong financial goals, check out our recent webinar.

Download our latest research paper, "Mining for Goals," which includes a worksheet that advisors can use with clients to identify more meaningful goals.
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