Tuesday, May 8, 2012

Playing the Lottery Might Be Rational – Only If You Don’t Get Addicted

Recently, I saw a blog post by an author with training in economics, L.E. Modesitt, noting that many female students who sought to make a career out of being an opera singer – something that is increasingly very unlikely for anyone – did not take actions necessary to maximize their chances to do so, and expressing bewilderment at their irrationality. I have seen this kind of analysis frequently in the past – it is, afaik, an accepted part of our beliefs. And yet, there appears to me to be a strong case that certain ways of taking long-shot chances – in one way or another, playing the lottery – are rational, are beneficial for the person, and are beneficial for the economy.

At this point, I have to stop and emphasize that, as I note in the title, this is no way, shape, or form and encouragement of anybody to play the lottery in any way. Not until it is very clear how people in general can avoid gambling addiction as a result of playing the lottery. No, this piece is aimed specifically and only at the non-addicts analyzing this behavior, hopefully so that they will see the rationality of certain types of playing the lottery and shape our policy approach to it accordingly.

At the same time, I have to note that this type of rationality, it seems clear, can be achieved. Once I realized the rationality of certain lottery-playing, I practiced it myself, over 15 years. Once the conditions no longer applied, I stopped immediately and completely, and haven’t played the lottery since, over the last 4 years. Although I didn’t win, the net negative effect on my net worth today was approximately 0.003% -- and if you think that matters, I have a bridge in Brooklyn I’d like to sell you. So it is doable.

Setting the Stage: The Players

First, let me give you a very crude picture of those who could potentially play the lottery, as I see it, in our society. There are four levels: the rich, the about-to-be-rich, the middle class, and the zero/negative net worth. Approximately, these break out as follows: the rich 0.3% of us; the about-to-be-rich another 0.3%; the zero/negative net worth, according to recent figures, 40% (50% of blacks and, I think, probably Hispanics); the middle class the remaining 59.4%. I am, I believe, probably underestimating the proportion of zero/negative net worth and overestimating the proportion of middle class; but those are the best figures I have.

Now, understand the nature of these four levels. The rich I define as those with about $2.5 million or more in investment wealth, stocks and bonds. According to my analysis, it is extremely hard for them to avoid becoming richer over time. Therefore, they have no need to play the lottery; fundamentally, they are secure and able to buy almost all of what they want immediately, forever. The about-to-be-rich are mostly CEOs; they have effectively guaranteed the income that will land them in the rich within approximately 1-6 years. Therefore, they have no need to play the lottery, either. Playing the lottery, up to extreme limits (such as thinking you can be a poker champion in Vegas), for these people, is not rational or irrational; it’s just irrelevant to their ultimate well-being.

Now we come to the middle class. By this, I don’t mean the traditional definition of middle class. I mean those who have every incentive to save rather than spend immediately in order to reach partial income security once they reach retirement, enough under most circumstances to allow them to live out their lives with prudent money management, but not enough to make them rich and without worries. These would play the lottery, rationally, for one fundamental reason: it is a choice between never getting rich and getting rich right now. It seems to me, based on the numbers, that there is a vanishingly small chance that any of these will get rich without taking a long-shot chance; and a lot better chance than that, if you take that long-shot chance. If, therefore, the accumulation of long-shot chance taking does not cost you a significant proportion of your ultimate net worth, then it seems to me to make a good deal of sense.

Finally, there are those with zero or negative net worth. I feel – I don’t know if it is justified by the facts – that their rationality is vastly underestimated. It seems to me likely that if there were reasonable chances of getting into the middle class without placing yourself under such a crushing psychological burden (e.g., working two full-time jobs as a maid plus bringing up children) that few can be expected to bear it, that these zero/negative net worth folks would take it. Instead, they tend to spend the little money they get immediately, often on relieving psychological pressure: smoking, drinking, betting, etc. Unfortunately, those things tend to lead to addiction – and the lottery is very much of the same ilk. Still, it is on the face of it no better or worse than any other addiction; and the potential payoff, it appears to me from a very cursory study of winners, is to place at least half of those winners firmly in the middle class. A major percentage of lottery winners do start to show saving-instead-of-spending-immediately behavior and do keep positive net worth until retirement. In other words, for this level, playing the lottery in ways that maximize your chances of getting into the middle class forever is entirely rational.

At this point, I have to pause to make sure that people understand fully what I mean by playing the lottery. Seeking out a job in a start-up company is playing the lottery, typically done by middle-class types. The number of those who get rich out of doing so is, sorry, far less than 1% -- and the hit to one’s ultimate net worth is likely to be significant. However, in most cases, it will not kick you down to the next level – you just wind up at a lower pay scale in a “safe” job.

Likewise, for the top of the middle class seeking to become rich, sucking up to the rich or the about-to-be-rich or taking a flyer on company stock options is also a form of playing the lottery. In most cases, the lion’s share of the stock/stock-option profits will be taken by the about-to-be-rich; but if an IPO is a wild success, you may get rich, or very close. It’s a lottery. Likewise, everyone is trying to suck up to the rich and vacuum up their money in order to get rich themselves, so in all likelihood you won’t get enough of his or her time to succeed – not to mention having the rich person fire you if you fail. Still, it’s worth a try. It’s a lottery.

In effect, the real lottery (or trying to break into show business, or win a TV show) is the only realistic lottery available to the lower middle class and zero/negative net worth folks. You simply aren’t likely to get in sniffing distance of a rich person. Your little stock flyer won’t make that much. Nope, it’s the real lottery or nothing.

Addiction and Rationality

Hopefully, the above analysis will allow you the reader to guess most of what I’m going to say here. The object of the rational lottery play, at whatever level except rich, is to move up one level, or move up far sooner than you otherwise would. To maximize the chances of that happening, you have to maximize the odds of success and establish a reasonable lower limit on negative consequences. And one more thing: you have to minimize the chances of addiction.

It may seem that simply setting a maximum amount to be spent per year on a lottery is sufficient to avoid addiction. In fact, it is not. Any time you play the lottery, in my experience, you wind up with an incredible swing in emotions, hovering near a high between the moment you place your bet and the time when the results are down to an incredible low immediately after – all of which lead to a strong desire to experience the high again, immediately.

That’s an addiction. The best way to avoid it, I believe, is to minimize the number of times you bet, and to avoid reminders that the bet is on until the results are announced. In effect, you make a bet once a year, and then get on with your life. And if you turn that approach into a habit, the habit itself will help prevent addiction, as any deviation takes undue effort. As I said, I know it can be done; and that was pretty much the way I did it. Again, I emphasize: that doesn’t mean I’m right. Let’s wait to do more analysis, and explore more ways. Don’t try this on your own.

First additional consideration: the amount for first prize in the lottery has to be enough to effectively move you up a level. Even $100,000 won’t cut it. My own rule-of-thumb cutoff back then was somewhere between $1 and 2 million dollars, since, after taxes and net present value reduction from installment payments, that would wind up being $600,000 to $1.2 million.

Second, one of the most effective ways to reduce the odds is to choose a lottery in which the maximum prize is the only prize. Other prizes simply reduce your odds of getting the maximum prize.

My wild guesstimate of the chance of success for lower middle class types and below over a lifetime is somewhere around 1 in 10,000. For upper middle class types who have more access to rich people and more reserve cash to allow playing lower-odds lotteries, I’d guess it’s 1 in 100. Either way, if you do it right, the alternative to winning is simply no real change in your net worth, so it’s always rational to do this.

From an Economic Point of View

It also seems to me that this kind of lottery-playing is beneficial from an economic point of view, if it does not increase gambling addiction. Thus, if it does not increase the net debt in the bottom level, and does not drive middle class participants into the bottom level, what we have is a significant increase in the assurance that middle class types will not need assistance in retirement, while preserving in most cases their incentive to defer spending partially in order to save – effectively balancing investment and spending. We also have an increase in the spending and investment of some previously zero/negative net worth individuals – granted, only 0.01% of that 40%, but still a nice chunk of change to add to the economy.

One concern is the constraints on the entity running the lottery. Government lotteries, as have often been pointed out, have an unfortunate incentive to create addiction in zero/negative net worth individuals, which, will it does not necessarily make their lives dramatically worse off – it’s just one more straw on the camel’s back – do mean that these individuals get too far in debt, and that decreases their spending on new stuff rather than paying off debt, one way or another – so it hurts the overall economy until you can dig these folks out of their debt that you created.

Large-business lotteries, by contrast, by their nature tend to be less frequent and focused more on the middle class, which can more easily afford to spend on their stuff. So these tend to be relatively harmless – which is not at all to say that a gambling casino is harmless, since it short-sightedly maximizes profit by maximizing addiction, only that a McDonald’s or AmEx lottery game isn’t too bad.

And finally, we may note that lotteries would do themselves and their clientele a favor by sticking to multi-million-dollar prizes – except gambling casinos, which are more often selling entertainment rather than getting rich, anyway.

Summary and Conclusions

Hopefully, this will be short and sweet. I believe I may have found the beginnings of a way to encourage the bottom two levels, acting rationally in their own self-interest, to use lotteries to possibly better themselves and the economy. Thoughts, anyone?

1 comment:

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