Recently I heard an individual state that in graduate school his thesis was that playing / “investing in the lottery” might be a rational way to diversify your portfolio. His argument was that it would allow you to make a small “investment” in a potentially large "Once in a Lifetime" event.  Let’s see if his assessment is a logical approach to “investing” for a potentially high rate of return. 

I spent a short period of time last night to calculate the cost, potential rates of return and the opportunity cost from spending it on the lottery versus investing it in various traditional vehicles.   In developing the model, we must make some reasonable assumptions.  First, assume the person starts at age 18 and participates in one weekly lottery drawing until age 62.  Second, let's look at the cost / benefit of buying 1, 2, 5 or 10 - $2 tickets each and every week during that period of time.   Also assume they play the largest lottery in a given state, but which is no less than $3 million in a payout and the buyer never won a single dime until the final drawing they participated in.

Based on these assumptions, the total expenditures for the various ticket options would be $4,576; $9,152; $22,880 and $45,760, respectively.  

Using the assumptions above and a $3 million prize, the rate of return for each ticket option (1, 2, 5 or 10) would be as follows: 15.88%, 14.07%, 11.72% and 9.97%, respectively.  If the jackpot was $10 million, the rate of return for each ticket sequence would be: 19.10%, 17.23%, 14.82%, and 13.02%, respectively.

Now, if you instead invested your lottery purchases in an investment vehicle which would earn an annualized return of 6%, 7%, 8% or 10% over the same period, the total returns per $2, $4, $10 and $20 ticket purchases would be as follows:

6%:   $22K, $44K,   $110K and $220K

7%:   $30K, $59K,   $148K and $296K

8%:   $40K, $80K,   $200K and $401K

10%: $75K, $149K, $373K and $747K

Now let’s look at a casual buyer of a ticket(s) that only plays once the lottery is at $100 million or more.  Obviously the frequency of their opportunity is much smaller as the odds of many weeks passing by where no one wins is much lower than regular payouts.  Using the same assumptions above including a ticket sequence (1, 2, 5 and 10 tickets per drawing) and using 10 yearly occurrences over 44 years, the total expenditures for the various ticket options would be $880; $1,760; $4,400 and $8,800, respectively.  

Using the assumptions above and a $100 million prize, the ROR would be for each ticket option (1, 2, 5 or 10) as follows: 30.29%, 28.25%, 25.61% and 23.64%, respectively.

Likewise, if you instead invested your lottery purchases on any lottery greater than or equal to $100 million in an investment vehicle which would earn an annualized return of 6%, 7%, 8% or 10% over the same period, the total returns per $2, $4, $10 and $20 ticket purchases would be as follows:

6%:   $  4K, $  8K,   $  21K and $  42K

7%:   $  6K, $ 11K,   $ 28K and $  57K

8%:   $  8K, $ 15K,   $ 39K and $  77K

10%: $14K, $ 29K,   $  72K and $144K

What's staggering is that there are so many people that spend between $10 and $20 one or two times a week and we're not even counting scratch off tickets and other games of chance.  Think about that for a second!!!  If you have a twice weekly player that spends $40 a week and matched their investment aggressiveness with their penchant for playing a high risk, high reward game such as the lottery, they could potentially have well over $1 million at age 62 (remember my numbers assumed they only played once a week)!!!!!  They don’t even need to spend that much to have a nice nest egg.  All they would have to do is cut their purchases to a single ticket and invest the differential and the numbers would still be significant.  This data confirms that consistent lottery spending by the poor is a transfer of substantial wealth from the underclass to the state governments……………..

So remember, if it is not morally objectionable, playing the lottery should be done with very few dollars with high payout opportunities.  If you are a frequent and large scale player or you belong to a group (such as work) or know someone that falls into the category described above, you need to reflect on this data.  Maybe the lottery player committing $10 or more a week needs to find an advisor who will get them to move in a positive direction!!!!

Rate of return calculations source:  www.moneychimp.com

Tom is the Founder of TRG and has been the President and Chief Investment Officer since 2008.