It’s official: The United States has contracted lottery mania. The Powerball is a nationwide drawing of six numbers with one lucky combination winning a jackpot that has now reached more than $1.5 billion, available to anyone age 18 or older for a mere $2.
Jumpstarting your assets from zero to Benjamin de Rothschild levels, whose personal wealth is currently just over $1.5 billion, whilst neatly bypassing the centuries spent building a respected and successful, multi-generational banking family? Well, that’s a pretty good night’s work, right? Meanwhile, your friendly neighborhood stockbroker is losing her mind watching the entire country collectively ignore her friendly advice regarding the wisdom of investing for the future.
Of course, given the absolutely crummy start of the year for stocks, that Powerball doesn’t sound quite so bad. In fact, the dire state of global finance and the sheer size of the winnings had our team at Equities wondering from a purely investment standpoint, how does the Powerball stack up? If you’re really broke, is it one of the better ways to spend two bucks?
THIS IS MY BIG CHANCE TO TURN MY LIFE AROUND!
One thing you can say about the Powerball is that the outcomes are limited, making it much easier to predict. Unlike stocks or bonds, where there are myriad different economic factors driving value that are next to impossible to accurately predict over time, the Powerball’s structure isn’t hard to understand.
The odds of hitting the jackpot, getting all six numbers correct, is one in 292 million. That much is knowable and clear in a way that no stock ever could be.
At first blush, one in 292 million is really, REALLY long odds. However, for some people, that figure is actually pretty promising. When dealing with games of chance, expected value, a way of adding up the value of every potential outcome based on its likelihood, is the name of the game. Looking at the Jackpot alone, that would add up to a result of -$2 every time but one, and $1.5 billion that one time. So, 292 million times -2, then add $1.5 billion, then divide by the 292 million potential outcomes, well you’re still looking at an expected value of over $3 a ticket. That’s a 150% return per ticket, making it an obvious buy, even without the rest of the prize structure factored in!
Slow Down There, Skippy
Of course, were that actually true, investment banks like Goldman Sachs (GS) would be buying up massive blocks of tickets. A 150% return is ridiculously good, even if it’s only going to pay out a tiny fraction of the time.
For starters, if more than one ticket has all six numbers correct, the jackpot gets split. That really hits the bottom line hard. Of course, the higher the jackpot figure, the more people rush out to buy tickets, making it even more likely that you’ll have a split pot even if you win. That alone pushes the expected value of a lottery ticket into negative territory.
After that, there’s also taxes to consider. Taking in huge sums of money in one go like that would result in a tax burden in excess of 30% of the winnings. Finally, the $1.5 billion is only available as an annuity paid annually for 30 years. The lump sum payment is significantly lower, further hurting the overall expected value.
But Hey, the Stock Market is Tanking Right Now!
Of course, one may be tempted to look at the current state of markets, with calamity in China spreading across the rest of the world and bringing everyone’s IRA down with it. However, that would be pretty shortsighted.
Depending on how much risk you want to take on, investing in stocks can be pretty reliable...save for some brief periods when things go very wrong. Take a look at the returns of the S&P 500 over time: the lowest return you would get over any 25-year period was 9.28% a year. Over time, the ups and down even each other out in favor of a steady, reliable return. Get in and stay in for long enough with an index fund focused on the S&P 500 and, barring something we’ve never seen before happening very suddenly, you’ll be getting a pretty decent return.
The biggest factor boosting stocks here is the return of principle. A $2.00 Powerball ticket is going to result in you losing 100% of what you invested almost all of the time. However, buying $2.00 worth of stock, even a really terrible stock, would likely only result in a complete loss of principle in the event of some sort of massive fraud. More likely, even the worst years in a large enough stock will result in a 20-30% loss. And, even there, you’ll still hold equity in that company, so a bounce back would benefit you, as opposed to lottery tickets which just lose and then…are always just losers.
Simple Math Can Still Be Bad
The lottery is simple enough that we can produce a clear expected value figure based on the number of tickets sold and the size of the prize pool. There’s no such calculation available for stocks. Don’t get me wrong, people have tried, but the best they can muster is still frequently wrong.
However, the simplicity of the lottery is actually a huge liability when you consider the fact that it’s a negative expected value. In this instance, it should be perfectly obvious that buying lottery tickets is a massive waste of money almost all of the time. The precise odds of a stock providing an investor with a positive return on her money are impossible to calculate, but that at least leaves space for a chance at success. The lottery can be calculated, and the calculations say no.
Even if you’re a real gambler, someone interested in big returns and willing to take big risks with your money, you’re still better off rolling the dice on emerging growth companies that have a chance to take off.
DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer