Lottery Strategy

The New York Times had an entertaining article on why playing the lottery is worth it. It agrees with my point of view. One dollar now and then is a cheap price to play for the fun of dreaming about winning.

But it also included this gaffe:

Large rewards make most people reckless, whether they’re on the winning or losing end. A 2003 University of Vermont study found that lottery players who said they preferred to receive potential winnings in annuity payments — generally thought to be safer than receiving the money all at once, in a lump sum — often changed their minds when they actually won. And the higher the jackpot, the more likely people were to prefer a lump-sum payout, the researchers found. (Mr. Nabors chose a lump sum.)

Yes, people change their mind. They should. Taking the lump sum is a smarter thing to do. It’s not being greedy, it’s being prudent.

Ever wonder how the exact payout amount is determined? It’s pretty straightforward financial calculations, figuring out the present value of those annual payments. As always, the key input is the interest rate. And for this, they use a very conservative number. Why? Because the lottery has to invest in state bonds and other very conservative investments, so from their point of view, that is appropriate. However, you as a private investor, can do better in the market (in most cases). You have investment options available to you that the state does not. Therefore, you can generate a higher rate of return. Which means you get more money by taking the lump sum up front and investing it wisely.