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Chuck Jaffe Archives | Email alerts
Jan. 5, 2012, 12:01 a.m. EST
By Chuck Jaffe, MarketWatch
BOSTON (MarketWatch) "” Most people don't see playing the lottery as "investing" any more than they view playing the market as "gambling," but there are enough similarities that it's worth examining the behavior of the player, particularly at times when decision-making is critical.
If ever there was a critical decision to be made in the minds of most lottery players, it is happening in mid-January, when the price of a Powerball ticket is doubling, rising up to $2 per play.
Even if you've never bought a lottery ticket "” and count me in that group "” watching the way people react to the increase in the price of a lottery ticket might change the way you think about stock investing. No matter your feelings about the lottery, it may also show you why some investment strategies are not much more successful than systems for playing the lottery.
To see why, let's look first at the changes to Powerball.
Powerball is not quite a national lottery, but it is available in a majority of states. While there are nine different ways to win the game, the headline jackpot is won by matching five white balls in any order, plus the red Powerball.
Beginning Jan. 15, a Powerball ticket will rise in price from $1 to $2; the odds of winning will actually go up along with the ticket price, because organizers are reducing the number of red Powerballs by four to 35, meaning there's a 1-in-35 chance that a ticket is a winner at the very lowest level. The Multi-State Lottery Association is also raising the second prize "” for matching the five white balls "” to a minimum of $1 million, up from $200,000.
But the truth is that the "expected payout" is not actually changing at all. Powerball is a 50% payout game, meaning that half of all sales fund the game's prize pool; that is not changing with the price increase or the changing game matrix.
"The key here is thinking "?What's the expected payout for a dollar paid in?'' says Terence Odean, a University of California, Berkeley professor who studies investor behavior and financial decision-making. "You are now paying $2 to play, but the expected payout for all players is the same. It's not very exciting to have a lottery that says "Give me a dollar and I'll give you back 50 cents, so instead you have the vast majority of people losing everything they put in."
Odean says that lottery players are buying a fantasy. "You can fantasize about what you would do if you won the lottery without buying a ticket, but that's like seeing the fantasy in black-and-white," he explained. "When you buy the lottery ticket, you get to have the fantasy in Technicolor.
"But when you have to pay two dollars instead of one for that ticket," he said, "the colors don't get better and the fantasy doesn't improve." Read more: Financial tips for Mega Millions lottery losers.
Powerball organizers are betting that people will pay more for the hope of becoming a millionaire in a down economy. Statistically speaking, it's a pretty good bet.
Consider the various types of lottery players; there are the people who "invest" in tickets regularly. They have a regular set-aside amount, and while they might switch to a different game "” the price of a Mega Millions ticket is not going up and the odds of winning the jackpot are 175 million-to-1, or better than Powerball's 195-million-to-1 "” they more likely will stick with their routine and settle for fewer tickets for their gambling buck.
Then there are the people who buy a ticket a week, whose cost for the fantasy just doubled. So long as half of them stick with the game, Powerball revenues for that kind of player stays the same. Expect it to go up.
Finally, there are people who are in it for the "action," who want to maintain their number of chances, and who will double their spending (or at least increase it) to have the same number of plays.
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Chuck Jaffe is a senior columnist for MarketWatch. Through syndication in newspapers, his "Your Funds" column is the most widely read feature on mutual fund... Expand
Chuck Jaffe is a senior columnist for MarketWatch. Through syndication in newspapers, his "Your Funds" column is the most widely read feature on mutual fund investing in America. He also writes a general-interest personal finance column and the Stupid Investment of the Week column. Chuck does two weekly podcasts for MarketWatch, and frequently makes guest appearances on television, and on radio shows across the country. He is the author of three personal-finance books. His latest, "Getting Started in Hiring Financial Advisors," was published in the spring of 2010 by John Wiley & Sons. Collapse
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