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This is a guest post by The Weakonomist. His posts provide a excellent perspective on finance and I have enjoyed reading his posts. Please ensure you visit his blog and sign up to his RSS feed.
Over the last 18 months, I’ve watched everyone I care about lose faith in the stock market. It’s pretty much expected in any recession, but this is my first recession as an adult so it’s been painful to watch. This is especially painful because I am responsible for selling them on the power of compounding interest, only to watch the life sucked out of it. But encourage them not to lose faith, because it is in the darkest times that our faith is challenged.[ad#tdg-embedded]
Now that sounds like a religious phrase, and it is. Today I want to show you some parallels between religion and the markets, specifically in the loss of faith. I believe you can’t convince someone to change their mind if they’ve already taken a pessimistic view towards our economy (just ask my dad or my fiancé). It’s just like convincing an Atheist there is a higher power at work in the universe, you can’t do it. What you can do for both of them is open the doors with an argument they would be more inclined to agree with. This is where Financial Pascalism comes in.
That’s a new term, and you heard it here first. But what does it mean? Well around the time Louis XIV was getting settled into the throne (1650s) a French philosopher named Blaise Pascal introduced a religious philosophy that was groundbreaking and controversial. Pascal argued that you might as well believe in a higher power, because there is no downside. Example: In many Christian beliefs an Atheist will go to Hell because they do not accept Jesus as their Savior. If there is no God or hell, then both Christians and Atheists alike will cease to exist or whatever happens. Pascal would tell an Atheist to believe simply because there is no downside to not believing. In essence, you have nothing to lose. This became known as Pascal’s Wager.
I’ve adapted Pascal’s Wager to fit with a financial philosophy. Many of us have been told and live by the creed of saving 15% of our income for retirement. Most of us choose to invest that 15%. We are taught that on average stocks offer a greater long-term return than any other investment. This does require us to bite our nails a bit during recessions though, and some lose faith in the long-term over the fear in the short-term. This is not unlike someone losing their religious beliefs when times get tough. So you lose faith in markets, and put your money into safer investments, or cash. We all know you risk losing the potential upside when markets recover, but you can’t convince those pessimists to stay in based on the old rule-of-thumb.
This is where you introduce Financial Pascalism to the pessimist. Were Pascal alive (and an economist) today, he would tell them there is no downside to keeping your money invested in the stock markets during a downward slide. This is not because the markets will recover, but because of what you would lose if the markets didn’t recover. If everyone invests 15% of their income, and the economy fails, you’re only out that 15%. Sure it’s most of your savings, but everyone else lost their savings too. If you’re no worse off than anyone else, then you philosophically haven’t lost anything.
But what of the people that perhaps made money as the market crashed? They didn’t make money. If our markets crashed and the economy fails, then the money they made is worthless. As a society we would regress to older times in which today’s currency would have no monetary value. So a short hedge fund might have piles of cash, which will come in handy to make fires after World War III breaks out and the world is decimated.
That’s a bit extreme of course, but it drives the point home. The failure of the markets represents the total destruction of the world economy. You might as well continue to trust in the system, because there is nothing you can do to protect yourself if the system flops.
So what do think of Financial Pascalism? Can you sell your pessimistic friends on it? What would Pascal’s critics say of his modern day economic philosophy?
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