Many people today think that the only way to get rich is to win the lottery. That isn’t a good plan, but let’s look at the characteristics of people who play the lottery every week and see how they match up to the qualities required to actually build wealth.
- They have a strong, well-defined goal in mind.
- They are persistent and work toward their goal on a regular basis over many years.
- They make a priority out of achieving their goal. For example, they sacrifice regularly in order to make sure that they have their tickets for every drawing.
- They pay attention to news about their goal, devoting time and energy to watching the prize totals and checking numbers on a very regular schedule.
- They celebrate small victories such as winning $100 on a scratch ticket and try to repeat those victories by repeating the strategy that achieved it, such as buying a particular type of scratch ticket again after a win.
- They often reinvest profits, instead of pocketing $20 from a winner, they use it to buy more tickets.
All of these are traits that would serve someone well in getting rich, if they were accompanied by a real understanding of the investment vehicle to which they were applied. A lottery ticket is an investment just as stocks and bonds, gold coins, rare stamps, plots of land, or Bitcoins are investments.
Most of us would say that lottery tickets are bad investments, but why? A lottery ticket has a well defined initial cost. It will either be entirely worthless, or worth a very large sum. There are smaller prizes for partial wins, but let’s leave those aside as they don’t materially affect our equation. We know precisely the odds of winning the big prize or losing everything we paid for the ticket.
If we do the math, we can determine the real value of a lottery ticket (which varies depending upon the grand prize value). Let’s say, that one particular lottery has 300,000,000 possible combinations and only one wins the prize. Our odds of winning on a single ticket, therefore, are 1 in 300,000,000. If the prize this week is $50,000,000 and the cost of a ticket is $2.00. What is the real value of the ticket when you buy it?
The math, discounting smaller prizes for the moment, goes like this: $50,000,000 divided by 300,000,000 equals 16.667 cents. So, you’re paying $2 for something worth only 16 and two-thirds cents at best. That doesn’t take into account the fact that there might be two or more winners, requiring you to split the prize which would drop your ticket’s value at least in half. It also doesn’t take into account that the $50 million is paid out over 25 years. If you want a lump sum now, you might only get $24 million, which again drops the value of the ticket in half (as does taking the longer payout option due to things like inflation and opportunity cost).
Does buying more tickets improve the quality of the investment? No. If one ticket is worth 17 cents (let’s round up) and costs $2, then spending $4 for tickets worth a total of 34 cents does not make things better. Carrying that all the way to the extreme, imagine buying all the tickets, so you are guaranteed to win, You’d have spent $300 million and would receive only $50 million back- a loss of $250 million before considering the possibility of splitting the prize with multiple winners and the discounts for lump sums or long-term payouts. No matter how you look at it, that’s a bad investment.
Furthermore, there is nothing you can do to improve the value of your investment. What about those rare times when the jackpot amount exceeds the odds? In theory, doesn’t a large enough jackpot make the value of the ticket more than $2 at the time of purchase? Almost. The likelihood of multiple winners, and the discounts on the payout value that I’ve already mentioned cut the value by a factor that’s difficult to quantify unless you know precisely how many tickets are going to be sold and you use the lump sum value rather than the long-term payout. In either case, it is exceedingly rare that a lottery ticket is ever worth anything close to its face value.
A good investment is one that has an expected future value greater than the amount you pay for it, when taking into account things like inflation and other risks. Clearly the lottery is not a good investment. Applying the same traits that habitual lottery players apply to something with a better likely outcome, however, can result in a successful investment strategy.
A winning investment strategy consists of the following:
- Have a well-defined goal that takes into account risks versus potential rewards.
- Be persistent and work toward your goal on a regular basis by regularly investing over many years.
- Make a priority out of achieving your goal. For example, don’t skip investing or withdraw frivolously for short-term rewards. Stay focused on the long-term goal.
- Pay attention to news about your investments, devote time and energy to learning about and understanding potential investments and investing in general.
- Celebrate small victories and try to repeat those victories by understanding and repeating the strategy that achieved them.
- Reinvest profits, instead of pocketing a small quarterly dividend, reinvest it to use the power of compounding to multiply your original investment over time.
Sound familiar? So the real difference between lottery players and successful investors is being able to differentiate good investments from bad investments. The goal of our Investment Group Discussion Club, and eventually our investment club, is to help members learn how to evaluate the risks and potential rewards of potential investments and to practice winning investment strategies that help them meet their long-term goals. (Note that “long-term” may have different meanings for different members, but should generally be measured in years rather than weeks or months).