pascal's wager applied to personal finance

Applying Pascal’s Wager to Personal Finance

Erik Financial Education, Thoughts of a Mastermind

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pascal's wager applied to personal financePascal’s Wager is an argument about the belief in God from back in the 1600’s.

Blaise Pascal, a philosopher and mathematician, came up with a wager which should affect the way a rational person lives their life.

Pascal’s Wager is as follows:

  • Either God exists or God does not exist. There are no other alternatives and you need to decide on one of the options.
  • If God exists, depending on your decision, you will experience an infinite gain (Heaven) or an infinite loss (Hell)
  • If God doesn’t exist, you experience a finite gain (not wasting time at church) or finite loss (wasted time going to church possibly)

Given this decision, there are 4 outcomes.

God ExistsGod doesn’t exist
You believe in GodYou go to Heaven (infinite gain)You waste headspace and time (finite loss)
You don’t believe in GodYou go to Hell (infinite loss)You don’t waste headspace and time (finite gain)

This isn’t a religious blog, and I don’t ever plan on making it a religious blog.

Erik, what the heck does this have to do with personal finance???

Well, let’s take this wager and apply a variation to a few different financial scenarios and you’ll find out 🙂

Pascal’s Wager Applied to Saving

Let’s apply a variation of Pascal’s Wager (that I just came up with) to saving and building wealth over time.

Instead of deciding if you will believe in God or not, you have to choose if you are going to save $10,000 a year or save $0 a year and take a $10,000 vacation every year in place of saving.

Some people don’t save anything because they think saving and investing is a gamble, or maybe they just want to live it up now and postpone real adulthood for the future.

I’m not sure the real reason for why the savings rate in the United States is roughly 3%, but I’m getting side tracked.

For your savings, investments have the possibility of growing at either losing 7% or 7% a year for 30 years.

Let’s get look at our table:

Investments Grow 7% for 30 YearsInvestments Decline -7% for 30 Years
You save $10,000 a yearYou end up with $944,000 (nearly a millionaire!)You have $127,000 in 30 years. (still a good chunk of savings!)
You save $0 a yearYou end up with $0.You still end up with $0.

I’ve never actually ran the calculation for continually declining markets and was surprised that you still end up with a decent nest egg!

Arguably, you lose in either scenario by not saving, while by saving, there is the potential for a big loss, there is also potential for a massive nest egg at the end of the day!

While yes, you could have taken 30 $10,000 vacations in the last 30 years, if markets are up 7% a year, you will be able to take 12 or 94 $10,000 vacations going forward and still have money – not bad (and your non-saver counterpart will still be working!)

I think the answer is obvious here, saving money each and every year over time WILL result in wealth at the end of the day.

Pascal’s Wager Applied to Spending

Okay, let’s do another example.

Instead of saving, let’s look at the other side of the equation, and in particular, look at debt financed purchases and how it affects wealth building over time.

In this variation of Pascal’s Wager, you are planning on taking that $10,000 vacation that we talked about in the previous section.

For one of the choices, you can “just swipe the credit card, honey!” and pay the minimum payment over time, and for the other choice, you pay cash.

In a year, you may buy a house depending on the market. With your potential credit card debt, you have a choice to make (I’m ignoring the fact here that banks view credit card debt as relatively minor compared to other debts when applying for a mortgage, but I digress.)

Here, let’s look at our table:

You find your dream house next yearYou don’t find your dream house
You swipe that plastic!You have less than full borrowing capacity and are a slave to the bankYou are still paying for an old expense and are a slave to the bank
You pay cash!You have full borrowing capacity and are not a slave to the bankYou are able to do whatever you want with your monthly cash flow and are not a slave to the bank

Looking at our table, using debt vs. cash favors a clear winner: paying cash.

Now, I’m not advocating that you never get into debt (I have a mortgage, a HELOC, and multiple credit cards to my name), but want to make a point here that debt RESTRICTS your lifestyle over time and prevents you from potentially doing what you want with you life.

By improving your lifestyle with debt, you can pull the future to the present, but unfortunately, you will have to pay for your present enjoyment at some point.

Concluding thoughts on Pascal’s Wager Applied to Personal Finance

I love going back and seeing what smart people said in the past and look to apply it in present times.

With saving money and paying down debt over time, it would seem it is quite difficult to fail to build wealth when looking at the alternatives of not saving and not increasing debt over time.

Personal finance is a series of choices. If you make the right choices over time, and perform them frequently, you will build wealth. Choose the wrong choices, and, well, best of luck to you.

I hope you enjoyed this silly post, as I really enjoyed writing it for you 🙂

Readers: what is your reason for saving? Are you comfortable with debt or do you hate it?

Erik

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