Investing versus Gambling

I read the other day that the price of Powerball ticket is increasing from $1 to $2 on the 15^th of January.  So, for the same expenditure, lottery ticket purchasers will get half as many chances to win or, if they want to maintain a pattern in number of tickets purchased, they will spend twice as much for the same number of tickets.  The good news is that the chances of winning are actually going to increase, as the lottery commission is reducing the number of red Powerballs by four, to 35, and increasing the second prize to $1 million, up from $200,000.  Why do people want to play the lottery?  Why are some players habitual players, while others are only occasional recreational players.  A sad indictment is that lotteries have been shown by research to be an inferior good, where more tickets are purchased, the lower the income of the purchaser.  Maybe they just don’t know any better or maybe they are really desperate. 

 

The payout on Powerball remains at 50% of the funds from the sale of lottery tickets, so lottery players will continue to expect to receive $0.50 for every $1 of tickets purchased.  The overwhelming majority of lottery “players” lose everything they spend on lottery tickets, yet they fantasize by buying tickets in the hopes that their financial lives will change.  There are even lottery ticket purchasers who claim to be “investing” in the lottery when they buy a ticket, with the knowledge that they only expect to receive half the price as a return from their “investment”.   Many people, in fact, buy lottery tickets like some of us save for retirement, through dollar-cost averaging.  When we dollar-cost average into retirement savings we purchase more, say, mutual fund shares when prices are lower and less when prices are higher, by making the same periodic investment.  If the market rises over time, we are assured that we will have more money at the end of our investing cycle than the principal we put in.  Lottery ticket dollar-cost averaging purchasers buy the same dollar amount of tickets each week with relative certainty that they will get half the money back.  Is this extreme fantasy or simply quiet desperation to hope to be the one in 195 million players to win the jackpot.

 

The gambler and the investor are linked, however, as both are driven by the amount they are gambling/investing and the “action” they receive from the process.  Those driven by the action will put more money into the game, as they are excited by the game.  It is curious, however that when a stock sells at a high, say a three digit (APPL) or six digit price (BRK-A), investors shy away from the stock.  The high price, relative to other stocks, causes many investors to be reticent to buy the stock as it is high priced.  Those same investors might be willing to purchase low-priced, “penny stocks” in the hope of finding a hidden gem.  Neither the investor nor the gambler is rational, if they continually spend/invest large sums of money on low probability events.  The cumulative value of losses in these “investments” can be quite large.

 

When lottery tickets were just becoming commonplace, I heard a financial planner call them a “tax on stupidity”.  Given the wide gap between the cost and the expected value of the payout, why would anyone buy a lottery ticket?  Perhaps, some people simply enjoy paying money to others so they can lose their money.  It is not, however, the path toward financial success.  I have read that one in ten British citizens believe that they will win the lottery to pay for their retirement.  That is not a retirement plan.  Rather, periodic dollar-cost averaging, across a lifetime of saving and investing in a diversified portfolio designed to reach financial goals is financial planning.  And, guess what, you will become a millionaire.  Now that you understand more about the lottery, you can see that lotteries really are a tax on stupidity……. those lacking your understanding.