The Butterfly Effect

The Butterfly Effect is the term given to the theory that small, seemingly insignificant actions can have far-reaching effects. The term was first used in the 1960s by Edward Lorenz, while modeling weather patterns. He theorized that the formation of a hurricane could be impacted by small movements, like that of a butterfly’s wing, occurring a long way away. It has been surmised that the only way to prevent these far-reaching events is to prevent the original small action happening.

So, what does the Butterfly Effect have to do with finances?

Let’s look at that definition again: small movements or actions can have a lasting effect, even after the action has stopped. When planning for financial security, it means that small savings or changes to spending now, can have far-reaching benefits in the future.

The reverse is also true though -- no savings or spending control now, will negatively impact financial futures.

The Butterfly Effect is about consequences; for every action, there is a consequence. Most of us learnt about consequences as kids – no TV until homework is done; no candy before dinner; being grounded for breaking the rules.

If you could fast-forward into your future, maybe to age 60, what would your financial situation be like? However it looks, it will be the consequence of actions you took and the choices you made along the way. If you want your future to be financially secure and stress-free, you need to consider what actions you need to be taking right now, to ensure that happens.

At the end of the day, we are responsible for the management of our own finances. We decide how and where to spend our money. No one else is going to look after us in retirement; the government certainly won’t by the time most of us get to retirement age.

Unfortunately, many people just don’t know how to manage their finances; some just don’t want to know, I guess. Modern society has us believing that we have to have it all and we have to have it now. This has led to enormous personal debt and financial hardship; I’m sure you know what I'm talking about.

But it’s OK; there are ways that you can change your financial destiny by using The Butterfly Effect for your future welfare. You make small choices and take small actions, starting now, to influence how your future is going to look.

You don’t have to squirrel away every spare cent and live frugally like a hermit, to achieve financial security. But it will take commitment to make regular small savings actions and sensible spending choices. Once you get the ball rolling in a savings account, it takes on a life of its own after a while. For example:

Let’s say you can save just $25 a month:

• After 5 years, at an interest rate of 2%, you will have $1,576
• After 10 years at an interest rate of 2%, you will have $3,318

If the interest rate was 4%, at 5 years you would have $1,657; at 10 years, $3,681.

If you are able to save $100 a month, the results are:

• At 5 years, $6,304 at 2% interest; $6,630 at 4%.
• At 10 years, $13,272 at 2% interest; $14,725 at 4%.

Now, these figures aren’t going to fund your retirement, but if you maintain this type of saving pattern throughout your working life, by age 60 the balance would be considerate. As you progress through your career, you should be able to increase the amounts you’re able to save. There are also many strategies that can help you improve on these results.

What are some other small actions that will Butterfly Effect you into a financially secure future?

They are the basics I've been covering here a lot lately on FMF. Check these out for more specifics:

• 80-20 Your Finances


• 30 Steps to Great Finances


• Becoming Wealthy May Be Simple, But It’s Not Easy

A few of the tips listed in these posts bear repeating because the keys to success, especially for those just starting out or those looking to get their finances back on track. For instance:

• Set financial goals. If you have no goal, you don’t have anything to work towards. Decide what you want to achieve financially and start to fund those goals immediately.


• Create a written budget and work to it. I know, you hate budgeting. So call it a cash flow plan. The truth is that creating and managing a cash flow plan really is the key to financial security. You simply must know where your money comes from and where it is spent. A budget shows you very clearly where you need to trim spending; it also shows you how much you can save and invest in your future.


• Establish effective saving habits, starting today. If you have been in the habit of spending everything you earn, this is going to cause you some short-term pain. According to the Butterfly Effect, this short-term pain will have far-reaching benefits for you. Regular saving, even of quite small amounts, is the key.

Once you see The Butterfly Effect is at work on your finances, you will discover other small choices that will help you work towards financial security and peace of mind. It is never too late to start making those small movements towards a good financial future.

Comments

[Christa]

Small choices can make a huge difference. Right now, my husband and I are thinking of setting up a college savings account for our baby, and we simply need to do so if only to get into the habit. We'll put a small amount away every month, but it'll help us develop a habit that we can grow upon later.

[Old Limey]

The three far reaching events that had a huge impact on our lives and finances were:

1) World War II
2) The Housing Bubble
3) The Dot.com (or Internet) Bubble

I lived in England during World War II and was a 5 year old child when it started in 1939. One day I was in our back yard looking after my little sister when I saw a German FW190 aeroplane flying very low right overhead. It was so low I could see the pilot. I then saw 2 bombs fall and heard a huge explosion. The bombs demolished a hotel about 100 yards away, killing a lot of Canadian airmen that were billeted there. If the pilot had pressed the release button a fraction of a second earlier I wouldn't be a 77 year old US citizen writing this post. BTW the plane was shot down over the ocean by a British plane that was chasing it.
The war also had a huge effect upon my life. WWII was followed immediately by the Cold War with the USSR which led to the arms race. My emigration to the USA and very successful career in aerospace would have never been possible if it hadn't been for the Cold War and the tremendous growth of the defense industry.

The housing Bubble also happened at a great time. We bought our 1st. home in 1963 for $27K, sold it in 1977 for $90K. We bought our 2nd. home in 1977 for $107K and today it's worth over $1M.

The Dot.com stockmarket Bubble also came at a perfect time for us. After retiring in 1992 I became a very active investor and as the bubble formed I was able to make 1000% before bailing completely out in March 2000 over a few days as the bubble burst and gave up almost all of its gains.

[Old Limey]

@Christa
It's just a difference of opinion but the idea of setting up a college savings account for a baby was the furthermost thing in our minds when our first child arrived two years after we were married. The two of us were totally alone in a new country with one income and very little in savings. Our priority was to just build up our own savings. We came from a culture where parents were expected to provide for their children, send them to public schools, and support them until they obtained a job and left home. Many years later when our youngest daughter expressed a desire to go to our local state university while living at home we offered to pay for her tuition and books. She had several part time jobs and decided that she wanted to pay her own way so we went along with it. She obtained her degree in marketing and was fortunate in obtaining a job managing a high rise office building. Fortunately, or unfortunately depending upon your outlook she met a very wealthy attorney and after the marriage he insisted that she give up the job that she liked so much even before they had children. As things eventually turned out she never went back into the workforce. After 18 years of marriage and the very sad death of a daughter she filed for divorce and obtained a settlement more than enough to support her the rest of her days. She is now in a new relationship, very happy indeed, and we go for a long hike in the mountains every Monday. Our other daughter went to a junior college, and our son never went to college but is a born salesman and doing very well.

[Matt]

Old Limey I love you wisdom. You remind me of my father who is 84.

If it were not for a bad relationship I would have not found my wife and probably happier. If it were not for a lay off in 1993 I would not have found my current employer. If it were not my constant contrarian attitude of paying off a mortgage I would not have my house paid for.

I could go on but that butterfly keeps bothering me about something.

[08graduate]

@FMF In a chaotic system where the butterfly effect applies, small changes in input have large, _unpredictable_ effects on output. If the butterfly effect described savings, it would be perfectly plausible that in 10 years, $25 a month of savings becomes $3000, but $24.90 a month grows to $10M, and $25.10 a month shrinks to seventy-three cents. Almost by definition, you can't "use" the butterfly effect, because you have no idea what the crucial moment for a small action is, or what the consequences of that action will be.

Fortunately, the mathematics of savings are actually linear. If you save a little less, the amount of interest you earn in a differential amount of time is _proportionally_ less. Your point, of course, is that the difference compounds exponentially over non-differential time. That's true, it's important, and it's under-appreciated, but it's not the butterfly effect.

[Melissa@LittleHouseInTheValley]

Taking advantage of the butterfly effect helps put you in a mindset to do more for yourself financially. One step in the right direction helps to lead to more steps in that direction.