Friday, December 7, 2012

Understanding the Lotto - $1,000/week for life

No doubt, if you have a pulse, you've seen the local lottery games demonstrating a chance to win $1,000/week for life.  To many, this seems like an enormous amount of money that simply cannot be beat.  Before we go into the real value of this money, let's first understand a little bit more on the probability of the lotto.

A wise friend once told me that playing the lotto was a game for people who didn't know how to do math.  Whereas this is a little harsh, I tend to agree.  You see, in the world of probability, the lotto simply does not warrant an investment.  To explain it a little more clearly, consider the formula of expected value (Ev=xp where x = an event and p is the probability of it occurring).  If the payout to a local lottery is $40,000,000 and the probability of winning is 1:1,000,000,000 then the expected value is $0.04 which is 25 times more expensive then the innocent looking $1 lottery ticket you just purchased.  So next time you purchase a lottery ticket, consider the expected value of the transaction.

Now back to the $1,000/week per life.  Ignoring the probability of winning, we'll just assume that you have already won.  Now, there are significant taxes involved with winning the lottery, but for arguments sake, let's just say they are 30% of your winnings.  So right off the bat, you are now making just $700/week for life.  Now let's take into consideration the yearly decreasing value of currency we like to call inflation.  If every year, your money's value decreases by 3% and your total money does not increase, then eventually over time, your money will become essentially worthless.  So if in one year you earn an after-tax winnings of $36,400 ($700 x 52), then dividing this number of 3% will give you the total lifetime value of your winnings in today's dollars (or $1,213,333).  This is no small amount of money, but it's hardly the same earnings other lottery opportunities would provide.  If we did the math further and subtracted the total future value of the money you invested over time in buying lottery tickets and it's opportunity costs, your total earnings would be much smaller.  This also doesn't take into consideration your own lifespan.

In the end, everyone knows that playing the lottery is not a profitable way of making money, and you're probably just throwing money down the drain.  The real value, however, is if the amount of fun you get from playing the "what-if" game is more then the financial cost.  Only then would I warrant a play.  As some of the slogans go "Hey you never know".

Wonderful Moment of the Day: TGIF!

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