Ask the Piggy Bank: Lotto or Savings?
October 9, 2007 by Miranda Marquit
Filed under Finance
The subject of today’s Ask the Piggy Bank has to do with playing the lottery. Many people regularly play the lottery, buying tickets about once a week. Those $1 tickets don’t seem like much, but they can sure add up. So, here is the question posed:
What wealth would someone accumulate if from 18 to 65 they saved $1 a week instead of buying lottery ticket?
A fabulous question. I’m going to do things very simply. Mainly because we can’t all be accountants, and I’m not an accountant. But it should give you an idea of what the general possibilities are.
First of all, the chances of you winning the lottery are very slim (check out this lottery calculator to help you figure it out). Using the lottery as an investing plan is a bad idea. If you just didn’t buy that ticket, and stashed that dollar under your mattress for the next 47 years (the amount of time between 18 and 65), you would have $2,444. But the fun starts when you use the power of interest to work for you.
Using a simple savings calculator, we can figure out how much you would have if you put $1 a week in a high yield savings account. I like online savings accounts. At the end of 47 years, if you had a 4.5% interest rate, you would end up with $7,740.65 in your account. With a better interest rate, you could do even better.
What if you invested that dollar elsewhere? Say you did a little dollar cost averaging with a mutual fund (some will let you open with as little as $50) or investments. This takes a little more derring-do, but happily for me, there is a more complex savings calculator available from CNN Money.
I pretended that I wasn’t going to save anything, but put my dollar in a tax-deferred IRA mutual fund. Starting with $50, and then putting the dollar in once a week for 47 years. In the end, at a modest 7% growth rate (it’s a boring mutual fund), that money would turn into $18,321.95.
While you might get lucky, chances are that you will never win the lottery, and that’s more than $2,000 down the tube. But if you invest that over the course of the 47 years, you can see that you would have much, much more. Add that to your already set out course of saving, and you should have no problem hitting retirement.
But if you must, set aside an extra $1 a month for the lottery (don’t diminish what you save, though!). I guess you still could get lucky.
Not bad, but if they play $5 a week (as most of my friends do) and they used your boring mutual fund IRA, they’d end up with 91,609.75 (tax free if it was a post-tax IRA). Not too shabby AT ALL!
So true! It doesn’t seem like much, but it’s amazing how it all works out in the end. That’s the power of having interest on YOUR side!
Yup, unlike giving all the odds to the house:)
One of the saddest things I see where I live is people spending $20 or $30 or $40 a week on lottery tickets, then complaining about the prices of things. With the odds against winning, it’s always seemed like a voluntary tax to me.
Good point Rick! A voluntary tax that doesn’t offer you a return if you pay too much (and even $1 is really too much). Can you imagine if that money went into an investment? Even just a savings account…
Miranda,
Just a quick note to point out to your readers that the results you are calculating over the 47 years are nominal results, meaning that they are not adjusted for inflation. To get to the real results, you must reduce your annual return assumptions by a further assumed annual rate of inflation for prices in the general economy. Most models assume a 2% to 3% rate of inflation for a developed country like the USA. But, that small rate of inflation can be disastrous to the outcome of your investment, especially if you are only earning, say, 4.5% per year on your money. You may end up with the amount of money you calculated in your article, but the purchasing power of that money will be much weaker after 47 years of general prices rising at 3% per year. This is why investing in things like equities (i.e., stocks) is so important over the long term. If you can earn, say, 11% to 12%, per year on average over those 47 years by investing in something like an S&P 500 exchange traded fund (ETF), you can better overcome the damaging effects of that 3% per year inflation in prices. You can also live a much sweeter life in retirement, knowing that you pretty much have the purchasing power to live the life to which you had become accustomed before you retired.
Thanks,
Logan.
Ah, the joys of inflation :0) And don’t forget the difference between core inflation and real inflation. At any rate, this was merely meant to be an illustration. Think of what would happen if the money was spent on lotto tickets and inflation still had its effect!
Great and informative article. Whatever happened to the old adage, a penny saved is a penny earned?!