What Does The Lottery Really Cost?

I’ve met more than one person, in my time, who has a lotto habit.  Now, I’m not going to knock playing the lottery every once in a while, since it’s cheap thrills; but I do want to show what it costs to make playing the lottery a retirement plan.  Let’s look at a popular lottery game available in Arkansas: Powerball^®.

Powerball^® is a multi-state lottery game that is drawn twice a week and costs $2 to play, with the option of increasing non-jackpot winnings by paying an additional dollar.  The prize starts at $40 million, with the odds of winning the jackpot at 1 in 175,000,000.*  Pretty slim.

So, let’s say you make a habit out of playing the lottery by buying a ticket for every drawing.  You do this since from the age of 25 to 65, as if it was your retirement plan.  How much money did you “invest” into Powerball^®?

Two dollars per drawing, 2 drawings a week, 52 weeks per year for forty years: $8,320.

I can buy a reasonable little car for that money.

Odds are, you may win a tiny prize a couple of times during this period, but nothing to write home about.  So you’re out the cost of the tickets, over a lifetime.  It’s not that bod, right?  Even so, there’s another cost we haven’t looked at – opportunity cost.

You see, when you buy lottery ticket, you not only are buying something that has very little value (a $40,000,000 prize into, say, 175,000,000 tickets brings the value to just shy of $0.23 per ticket), you’re also losing the money that money could’ve made for you.  Let’s pretend that, instead of buying a lotto ticket twice a week, you put that same cost into an entirely fictional account that has no costs or taxes and then compound it at, say, 7% over the 40 year period.  What would you have?  About $45,860.  That’s pretty expensive.

* Information from Arkansas Scholarship Lottery FAQs and Powerball.com.

‘Boots’ Theory of Socioeconomic Unfairness

“The reason that the rich were so rich, Vimes reasoned, was because they managed to spend less money.

Take boots, for example. He earned thirty-eight dollars a month plus allowances. A really good pair of leather boots cost fifty dollars. But an affordable pair of boots, which were sort of OK for a season or two and then leaked like [censored]* when the cardboard gave out, cost about ten dollars. Those were the kind of boots Vimes always bought, and wore until the soles were so thin that he could tell where he was in Ankh-Morpork on a foggy night by the feel of the cobbles.

But the thing was that good boots lasted for years and years. A man who could afford fifty dollars had a pair of boots that’d still be keeping his feet dry in ten years’ time, while the poor man who could only afford cheap boots would have spent a hundred dollars on boots in the same time and would still have wet feet.

This was the Captain Samuel Vimes ‘Boots’ theory of socioeconomic unfairness.”

― Terry Pratchett, Terry Pratchett’s Men at Arms

* I have to keep it G-rated around here, so let’s say “H – E – double hockey sticks.”

When Is a Steal Not a Deal?

The sickly real estate market and tremendously low mortgage rates have coupled to make houses particularly affordable, at least compared to previous housing prices and rates.  At least, that’s what the CNNMoney.com article “Home buying: Most affordable in decades” by Les Christie would have you believe.  The article is a surprisingly accurate echo of this press release from the National Association of Home Builders.*  I want to talk for a moment about a particularly illustrative sentence in the press release: “Among smaller housing markets, the most affordable was Kokomo, Ind., where 99.2 percent of homes sold during the fourth quarter of 2011 were affordable to families earning the median income of $59,100.”**

O.K., I just-so-happen to be from Indiana, so I know a little bit about Kokomo, and have visited many times.  Allow me to illustrate:

I lived a lot of my life in the blue area. Kokomo is the red area. I visited frequently.

Hopefully I have some local cred here.  I would like to take a minute to point out that Kokomo was one of the most depressed municipalities in Indiana just a year or two ago.  Unemployment was over 17% in 2009, and is currently 9.6%.   With the closing and reopening of Delphi (a major employer and automotive supplier) and its economic dependence on the auto industry, Kokomo, has been, in my experience, a volatile economy subject to wild employment swings.

So, is it any wonder that houses are “affordable?”  I would say the houses are cheap, but I fear that it’s the cheap housing of a municipal economy like Detroit.  Detroit also suffers by being dependent on the auto manufacturers for employment, which subjects them the severe swings with every business cycle.

So, does it make sense to buy a house in Kokomo?  Well, that’s an individual decision, but I would perceive buying a house in Kokomo, Indiana as a riskier act than buying a house in a community that has more stable and diversified employment.  After all, there were probably home buyers that thought they were getting a steal on a home in Detroit a few years before the neighborhood crumbled around them.  Buying a cheap home in struggling municipality may be a bad deal, even at a good price.

* Someone answer me this: if a media outlet is going to simply reflect a press release without adding any significant fact-checking to the article, why write an article?  Why not just copy-paste the press release?  And they wonder why news publishing is dying…

**  What the what!  That median income number is a lot higher than I would’ve expected, given my personal experiences in Kokomo.

You May Have More Than You Think – Renter’s Insurance

“Why would I NEED renter’s insurance? I don’t own anything of value,” says the person who never added up the value of their stuff.

Have you ever stopped to add up the value of your personal possessions?  You may own a lot more than you think.  Take shoes alone, for example.  I own shoes that would take about $250 to replace.  Now, if my apartment burns down, and I don’t have renter’s insurance, I’ll have to replace them.  Worst of all, I’ll have to replace them quickly, which means it’s unlikely I’ll get the replacement shoes at good prices.

Some of you may be saying “Hah, stupid woman and her ridiculous shoes.  I don’t have that many.”  Well, I only have a few pairs: winter boots, galoshes, sport shoes, flip-flops, work flats and dressy sandals.  I’m not Imelda Marcos, yet I have a pretty substantial amount of money in shoes.  Add to that the clothes, furniture, computer and electronic equipment, and household goods, and it would be a pretty substantial loss if I were to lose the contents of my apartment.

So, here’s a project for this weekend: take a video or photos of all your possessions and create a detailed list in a spreadsheet.  This is called a home inventory.  There are a lot of resources on the internet to help you create your home inventory, so I won’t go into great detail on how to do it, since it would only be repetitive.

Once you’ve created your home inventory, talk with you insurance agent about your coverage.  Do you have any possessions that should have a rider but don’t?  Do you have enough total coverage?  Will your policy cover your electronics for full replacement value of contemporary equivalents?

Finally, when you’re done with your home inventory, don’t just store one copy of it in your home.  What happens if your apartment burns down?  You don’t want to lose you home inventory.  This is why I suggest you use computer files.  That way, you can make a copy that can be kept offsite, by emailing a copy to your webmail or by uploading it to your private cloud or server.

Also, make sure you check your liability limits with your insurance agent.  Increasing liability coverage is generally very cheap, but can save your bacon if there’s an accident in your home.

A Moment of Perspective

Perspective

“The use of money is all the advantage there is in having it.”

- Benjamin Franklin

It’s easy, when you concentrate on measuring, acquiring, and protecting money to forget that it’s a medium of exchange.  The only value money has is that it is readily exchangeable for goods and services.

For many people, money represents emotions; such as love and safety.  Sure, having ready cash can easily solve quite a few problems and buy a reasonable facsimile of love, but unless your problem is the lack of money, more money won’t solve the problem.  Let me say that again:

Unless your problem is lack of money, more money won’t solve your problem.

Yet, how often do we look to money to solve our problems?  Are we too fat?  If we just had more money, we could hire a dietician and personal trainer, then we’d be svelte and beautiful.  This is forgetting that there are plenty of ways to lose weight on a budget, or work out on the cheap.  After all, why go through the hard work of finding a weight loss method that works for you and then follow it, when you can simply blame your weight problem on not having enough money?

Money isn’t the problem, so don’t blame your problem on lack of money.  Because, if you do, you not only have made developing a solution contingent on getting more money, you also cut yourself off from other possible solutions that don’t involve money.

Money is just a tool for storing and exchanging value.  It’s a great tool for what it does, but it’s not going to solve all your problems.  Instead of looking to money as a savior, see it for the tool it is.

Commoditizing Health Insurance – Putting the “Fun” in Fungible

These eggs are not fungible.

Here’s a 25¢ word for today: fungible.  Fungibility means that one thing can be exchanged for another.  It’s an important economic concept and is critically necessary for the functioning of our economy, but you don’t hear too much about it.  I also think it could be the answer to the problem of consumers selecting health insurance policies – more on that in a moment.  First, let’s look at fungibility.

When I say that our modern economy is built on the concept of fungibility, I’m not kidding.  take eggs, for example.  Think of the last time you went shopping for eggs.  You probably bought Grade A Large white eggs in a carton containing a dozen eggs.  You may have looked at them to make sure none were broken.  But, what you didn’t do, I’ll bet, is examine each egg for size, shape, weight and quality.  Why?  When you buy one egg, it’s the same as another of the same grade/quality.  One egg is as good as any other.  They’re fungible.

The fungibility of commodities is at the heart of creating a market for bulk goods like coffee, wheat, crude oil, gold and more.  All these commodities are traded on exchanges, just like stock and bonds.  Each commodity contract is standardized as to its quality, grade, quantity and location – the only area open to negotiation is the price.  Doing this allows decisions to be made very efficiently.  If you know you’re looking for 5,000 bushels of No. 2 Corn in March, then it’s a snap to find the price and decide whether or not you want to buy.

Health insurance contracts could take a lesson from this.

Think about the last time you shopped for health insurance.  If you don’t recall, you may be experiencing memory loss from a traumatic event.*  It was probably a pretty big pain, wasn’t it?  You had so many decision to make – high deductible or low, what are the premiums, what are the benefits, is my doctor in network, etc., etc.  By the end of the process, your head was probably spinning.  You probably picked the best thing you could, and hoped it would work.

What if you had, instead of a universe of custom contacts, a brief menu of standardized contracts?  Wouldn’t it be easier to make a decision?  Like the life insurance industry has done with life insurance contracts, only even simpler.  Of course, cookie-cutter contacts won’t do the job, so why don’t we use policy riders to customize the policy to the customer’s particular needs.  And, why don’t we standardize those riders?

Because, just informing consumers by creating informative labels won’t make shopping for health insurance easier.  I applaud the intent of the Department of Health and Human Services in their attempt to label health insurance policies.  The problem is that they’re ending up with an informative label made of six pages of this:

Wow. This is simple and straightforward. Not.

That’s not going to help.

Six pages of small type doesn’t help you make a decision.  It confuses.  It’s helps the customer understand once they’ve bought the coverage, but trying to compare three or four policies to each other with this is going to be ugly.

That’s why I suggest that health insurance become standardized and commoditized.  If you want people to make better choices, you need to make the choices simpler and easier to compare.  Adding more information to the process doesn’t do that job.

* Thank you, thank you, I’ll be here all week.

Financial Literacy Quiz

Test your financial literacy!  Are you smarter than most middle-age Americans when it comes to money?  Find out!

Part 1 – Basic Financial Literacy

1. Suppose you had $100 in a savings account and the interest rate was 2% per year. After 5 years, how much do you think you would have in the account if you left the money to grow?
   1. More than $102
   2. Exactly $102
   3. Less than $102
   4. Do not know
2. Suppose you had $100 in a savings account and the interest rate is 20% per year and you never withdraw money or interest payments. After 5 years, how much would you have on this account in total?
   1. More than $200
   2. Exactly $200
   3. Less than $200
   4. Do not know
3. Imagine that the interest rate on your savings account was 1% per year and inflation was 2% per year. After 1 year, how much would you be able to buy with the money in this account?
   1. More than today
   2. Exactly the same
   3. Less than today
   4. Do not know
4. Assume a friend inherits $10,000 today and his sibling inherits $10,000 3 years from now. Who is richer because of the inheritance?
   1. My friend
   2. His sibling
   3. They are equally rich
   4. Do not know
5. Suppose that in the year 2010, your income has doubled and prices of all goods have doubled too. In 2010, how much will you be able to buy with your income?
   1. More than today
   2. The same
   3. Less than today
   4. Do not know

Part 2 – Sophisticated Financial Literacy

1. Which of the following statements describes the main function of the stock market?
   1. The stock market helps to predict stock earnings.
   2. The stock market results in an increase in the price of stocks.
   3. The stock market brings people who want to buy stocks together with those who want to sell stocks.
   4. None of the above
   5. Do not know
2. Which of the following statements is correct?
   1. Once one invests in a mutual fund, one cannot withdraw the money in the first year.
   2. Mutual funds can invest in several assets, for example invest in both stocks and bonds.
   3. Mutual funds pay a guaranteed rate of return which depends on their past performance.
   4. None of the above
   5. Do not know
3. If the interest rate falls, what should happen to bond prices?
   1. Rise
   2. Fall
   3. Stay the same
   4. None of the above
   5. Do not know
4. True or false? Buying a company stock usually provides a safer return than a stock mutual fund.
   1. True
   2. False
   3. Do not know
5. True or false? Stocks are normally riskier than bonds.
   1. True
   2. False
   3. Do not know
6. Considering a long time period (for example 10 or 20 years), which asset normally gives the highest return?
   1. Savings accounts
   2. Bonds
   3. Stocks
   4. Do not know
7. Normally, which asset displays the highest fluctuations over time?
   1. Savings accounts
   2. Bonds
   3. Stocks
   4. Do not know
8. When an investor spreads his money among different assets, does the risk of losing money:
   1. Increase
   2. Decrease
   3. Stay the same
   4. Do not know

Answers:

Part 1: 1, A; 2, A; 3, C; 4, A; 5, B.

Part 2: 1, C; 2, B; 3, A; 4, B; 5, A; 6, C; 7, C; 8, B.

So, how did you do?  I’ll bet it came as no surprise that “Do not know” was never the correct answer (even if it is true.)  The reason that answer is included is that these questions are from Rand American Life Panel’s consumer survey.  Read more about the survey, it’s methodology, and results here [PDF].

Did you miss some questions?  You’re in good company.  Less than half of the survey sample got all five of the basic questions correct, while less than on-fourth of the sample answered all the sophisticated questions correctly.