The ‘Butterfly Effect’ of Our Financial Decisions

The “butterfly effect” refers to the metaphorical idea that a butterfly flapping its wings on one side of the world can, through a series of chain reactions, cause a hurricane thousands of miles away.

I recently learned that the metaphor has its roots in chaos theory, which is an area of study that tries to work out how complex systems work. In that context, the butterfly effect refers to the way that “a small change in one state of a deterministic nonlinear system can result in large differences in a later state.” In other words, seemingly small decisions can end up having huge impacts down the line.

I’ve been thinking about how the Butterfly Effect is applicable to financial decision making. We can all look back and identify little choices that, only in hindsight, could be identified as having tremendous importance.

I’ve identified three inflection points in my life when small choices I made had a dramatic impact on my financial future. Curiously, two of the three decisions are ones that I regretted at the time. But, because I was able to learn from my errors, the ultimate ripple effect was still a positive one.

Discovering the Bogleheads

When I got my first paycheck post-college, I had no idea what to do with it. Ditto for the second and third. One day, bored, I started to search the internet to see if I should be doing anything besides building up my online savings account.

I stumbled across a site with a curious name: Bogleheads.org. They’re a community dedicated to discussing the investing advice of John Bogle, founder of the investing firm Vanguard. Their mission statement emphasizes “starting early, living below one’s means, regular saving, broad diversification, simplicity, and sticking to one’s investment plan regardless of market conditions.”

The whole ethos clicked with me, and I became interested in optimizing my finances. I wasn’t taught anything about money management or investing in school, so being a part of that community was eye-opening.

I learned that the stock market wasn’t just a nebulous thing that rich people used.

I learned that even someone like me, who thought a “yield curve” was a road sign you’d see on the highway, could manage his own investments without professional help.

I learned that fees really matter.

I could go on and on. In the alternate universe where I didn’t start Googling about investment strategies when I was bored that one time, I might still be convinced that the best investment was always a CD, since, hey, my grandma recommended them.

The effects have been long-lasting and demonstrably positive. Now, almost 10 years later, I’m still guided by the Boglehead maxims, which were so novel to me at the time.

Related: What Is Index Investing and Why Does It Work?

My First Panicked Stock Sell-Off

It was all fun and games investing in the stock market until it got choppy. As the famous Mike Tyson saying goes, “Everyone has a plan until they get punched in the face.”

In 2012, about three years into my investing journey, people started to fear that Greece would default on its debt. The global equity markets reacted poorly to this news, and I began to lose sleep watching my money dwindle. I eventually sold a lot of my stocks at a steep loss, but I felt relieved to at least be recouping some of my capital.

A couple months later, the market righted itself and started an upward march. I sat on the sidelines, fearful. It wasn’t until years later that I got back in.

I once started to calculate how much money I missed out on by sitting out the huge bull run from 2012 to 2015, but then I got depressed and stopped. Let’s just say I learned my lesson: If you’re going to invest in equities, you need to take the long-term view.

Thankfully, in the grand scheme of things, my mistake wasn’t that costly. If I were to sell during the next drop, the consequences would be even worse because I have a lot more to lose.

Learning a harsh lesson in the real world has helped me ride out subsequent stock market volatility with much more equanimity. Whenever I see the financial press start squawking about how the sky is falling, I remember my experience in 2012. I expect the ripple effects of that ill-timed sale will ultimately do me a lot of good.

Related: Why I Chose This Controversial ‘All-Weather Portfolio’ for My Life Savings

Cashing Out My Roth IRA to Pay Down a Portion of My Student Loans

In 2013, I finally got serious about paying down my student loan debt. I started using a portion of every paycheck to chip away at the mountain, but it didn’t feel like enough.

That’s when the money I had been diligently socking away in my Roth IRA started to feel like it was taunting me. Here was this decently-sized chunk of money that I couldn’t fully access for at least another 30 years. But, like an impatient child in a toy store, I wanted it now!

So I pulled it all out and put it toward my debt. While this felt good at the time, I realized about a year later that my decision was shortsighted. For one thing, I learned that there are tax implications that come with early withdrawals that I hadn’t bothered to look up. I was allowed to withdraw the money I had contributed tax-free at any time, but any interest or investing gains was taxable income until retirement. The whole point of using retirement accounts is so you can optimize your taxes, and I threw that advantage out the window. It’s important to do your research before messing around with retirement account withdrawals.

Also, my Roth IRA was invested in index funds, and the market has risen a lot since 2013. I lost out on more tax-free growth than I care to dwell on. You can’t go back in time to contribute to your Roth IRA: there are annual contribution limits. Once you sell, the opportunity to add funds for that year is gone forever.

To make matters worse, the market has grown at a much higher rate than the interest rate on my loan. I would have been much better off staying put, and I’m still paying the price for that.

One final negative was that I could have set a very bad precedent for all my future behaviors. Rather than thinking things through from all angles, I could have gone down a road of wanting things done quickly, regardless of whether it was the right long-term move.

Thankfully, in a similar fashion to my stock-selling foibles, I was able to make the initial negative into a positive. I still wish I hadn’t emptied out my Roth, but in realizing my mistake, I became highly motivated to learn a lot more about interest rates, tax optimization, and the power of being patient. In turn, I have become more cognizant about what the best financial moves are for my 60-year-old self, not just for me in the present day.

After that experience, I would never consider touching the money I have saved in my retirement accounts unless I had a true emergency. While paying down debt is a huge part of gaining financial independence, you can’t let it cloud all your judgments.

Related: Should You Prioritize Investing or Paying Off Debt?

Summing Up

I find the idea of the butterfly effect strangely comforting. I think it’s because, barring truly catastrophic choices, we can turn almost any bad decision into one that has long-term positive effects. All it takes is the desire to learn from it.

Rather than fretting about having to make the perfect decision all the time, you can change how you react to the decisions you do make. If you do your best to learn the relevant lesson, even silly things like panic selling can be a positive in the end.

Related Articles:

The post The ‘Butterfly Effect’ of Our Financial Decisions appeared first on The Simple Dollar.

Contributer : The Simple Dollar https://ift.tt/2LmgY8b