This is a guest post by Roshawn Watson of Watson Inc. If you like what you see here, be sure to download his free e-book “Your Foundation to Wealth” by signing up to receive free updates from his site via e-mail (no spam). You might also be interested in subscribing to his RSS feed or connecting with him on Twitter.
Some people are consumed with the idea of winning the lottery. While it is certainly easy to understand why this is so appealing, most of us know that we’d have a better chance of getting hit by lightning. Twice. Don’t believe me? Try this “Incredibly Depressing Mega Millions Lottery Simulator.”
But some people do defy the odds and actual win. What happens to them>? Their lives are certainly changed, but does their fairy tale have a happy ending?
It just evaporated…
Most of us have heard the stories of how lottery winners often wind up with nothing, regardless of how much they won. While it is certainly counterintuitive that one’s financial position would not be improved by receiving a tens of thousands of dollars (or more), it nevertheless still happens. A recent study has investigated this popular, but largely anecdotal, belief. The findings are quite fascinating.
This study included 35, 000 people who won between $600 and $150, 000 in Florida’s Fantasy 5 lottery game between April 1993 and November 2002. Winners who received $50, 000 to $150, 000 were compared to those who won less than $10, 000. The study found that the size of the jackpot had no effect on the likelihood of declaring bankruptcy regardless.
People who won $150, 000 were just as likely to go bankrupt in the next five years as those who won less than $10, 000. Instead of changing the overall incidence of bankruptcy, the larger winnings merely delayed the filings. In other words, while the smaller winners were more likely to file for bankruptcy during the first two years after winning, this trend completely reversed during years three to five.
It is equally interesting that the size of the winnings did not meaningfully impact the net assets of the winners at the time of their bankruptcy filings. For example, people who won between $25, 000 to $150, 000 only had $8, 000 net assets more than those who won less than $1, 500. This means that, even with a median jackpot size of $65, 000, the big lottery winners had virtually nothing to show for it.
The money didn’t alter their financial destiny. Instead, it just evaporated.
Identifying the root cause
Data like these are particularly troubling because they highlight the difficulties of merely throwing money at a problem. Presumably, winning a sizable jackpot should have given many of the large lottery winners a fresh start. Instead of capitalizing on this very rare opportunity, however, many squandered it.
Here are some possible causes:
- The found money phenomenon – Some attribute this to the “found money phenomenon.” In other words, people don’t place as high of a value on inherited or found money as they would if they had to earn it themselves. This is a form of mental accounting, a theory often based on subjective and irrational criteria that determine how we save and spend our money.
- Lack of financial literacy – Another possible culprit is a lack of financial literacy. Having money doesn’t change what you know, so the large winners were just as susceptible to bad money decisions as the smaller winners. Their larger winnings just made them less vulnerable initially. This is why mental leverage is often greater than having only financial leverage.
- Poor money management habits – Old habits are hard to break. If you are a habitual hyper-consumer, it would be very hard to resist the temptation of reckless spending, especially if you’ve just won the lottery. Additionally, knowing that you are overspending doesn’t necessarily birth fiscal conservatism.
- Poor financial context – I suspect that many of these winners lacked the context necessary to deal with their new jackpots. One’s financial context determines what they will strive for and ultimately achieve. Winning a sizable sum of money doesn’t correct one’s contextual deficits.
- Overconfidence – Many psychology studies have demonstrated that most people believe that they are above average. We typically believe that we are smarter or more skillful in a certain area than “average” people. I would also imagine that it’s hard not to feel confident (or at least lucky) after winning the lottery.
Internally bankrupt
These results are quite enlightening. For many, the data suggest that even receiving a large financial windfall will not have a meaningful impact on their financial destinies. The gift only appears to delay their inevitable financial ruin rather than preventing it.
These data also challenge the notion that a lack of money is the primary problem for many people. In fact, for many of the bankrupted lottery winners, the lack of money appears to have been only a symptom of problematic money practices. The fact that these individuals were even playing the lottery in the first place suggests that their net worth may never have been a primary concern.
Most importantly, these data indirectly suggest that we too should evaluate our financial blueprints. A defective money script can clearly be disastrous and often goes unnoticed because the damage is gradual.
We have a psychological connection to money as well as an external connection (i.e., money management skills as well as other head knowledge). It’s this behavioral and emotional connection with money that plays into the aforementioned mental accounting and overconfidence; these internal relationships with money have the biggest implications to us non-lottery winners.
The psychological aspects of money management may also lead us to discount the advice of skillful advisors, never consult expert opinion, invest large sums into things we know little about, get into debt, haphazardly start a business, etc.
Any of the above can be deleterious to our wealth, and can easily go unaddressed. It is quite challenging to prosper long-term while being internally bankrupt because our inner blueprints will continue directing us towards poverty and a lack of resources.
In aggregate, lasting financial change requires dealing with the underlying causes of our dysfunction instead of a myopic focus on our lack of money. It is important to keep in mind that sustainable enrichment is more than a dollars and cents issue.
Isn’t it possible that the lottery benefit for some people is lost due to too much generosity — giving money to friends and family or to charity? Generosity can be a real trap.
Also, it’s my understanding that most lotteries offer the option of taking your prize in annual installments rather than in one lump sum, which would greatly reduce the tax bite.
Here is another lottery simulator that convinced me to stop wasting my money.
http://justwebware.com/notalot/notalot.html
Hi, just want to be straight forward with my views, about winning lottery. I think most of the people dream of this. Because of my experiences in life, winning lottery would definitely fix my finances, why not? Somewhere we have to learn something.
@Lotto is fun. Thanks for sharing your opinions. Not only is making wise choices with your money (i.e. avoiding debt, investing, delayed-gratification, proper insurance, maintaining an emergency fund, maintaining adequate liquidity, etc.) the responsible thing to do, it typically builds wealth long-term which avoids bankruptcy in many cases when practiced consistently. This is what the data studying the balance sheet affluent shows. This is behind the assumption it is poor money management skills is the presumed problem that the authors of the study and I are making. However, I can understand that the study doesn’t explicitly address your concerns, so we’ll just have to agree to disagree on our interpretations of this one.
Looks like I missed a bunch of comments! Its probably too late, but in case anyone is still reading these comments –
@DanB. Glad to have provided you with a laugh – your ass could probably use the reduction if you routinely eat candy and drink soda! Seriously though, you may find a temporary pleasure in candy and soda, but the long term effects of eating these things is really not good. So, I would be perfectly justified in thinking that it is a far more stupid decision than the purchase of a lottery ticket.
@Steve in West MA. No doubt if I took every dollar I ever earned and invested it I could enjoy a very rich retirement. However, that isn’t going to happen – everybody spends some money on entertainment. I argue that the transient pleasure of candy is offset by the negative health effects. The lottery isn’t going to rot your teeth. Nor give you lung cancer for that matter.
Listen, I don’t care whether you choose to buy candy or girlie magazines with your hard earned dollars if that is what gives you the most pleasure. What I am pointing out is that if the lottery gives you pleasure, it isn’t stupid to indulge in it. Or any more stupid than buying any other thing that gives you transient pleasure. The only stupid thing is to spend too much on your little pleasures and not enough saving and investing. Or making the mistake of thinking that playing the lottery *replaces* saving and investing.
@Roshawn Watson. I completely agree with you that making wise choices with your money like committing to saving an emergency fund is the responsible thing to do. I’m just questioning your premise that everyone who goes bankrupt does so because of poor money management skills. The fact that the same number of lottery winners goes bankrupt as the general public leads to two interpretations 1) a fraction of the population is bad at money decisions, and extra money does not help them. 2) a fraction of the population goes bankrupt because of an overwhelming calamity, and an extra 25K does nothing to help them. It would be pretty easy to extend this analysis by determining the types an amount of debt that causes bankruptcy (a la Elizabeth Warren) which I believe is public record.
This certainly happens, but we’re typically not powerless to control our expenses regardless of our income/wealth. When expenses get out of hand, it’s usually because we let them get out of hand or because of some unusual/catastrophic event (divorce, sickness, job loss, etc) IMHO.
I say the bigger the button, the bigger the hole so to make the button fit in. The more money people have the bigger their expenses…
Sad but likely true, as pitiful as it sounds!
And then of course there’s that really small number of people who have won the lottery not once……but twice. The sample size would be so small that any study would be inconclusive………….but I’d bet serious money that winning the lottery 2 or more times wouldn’t improve the winners’ long term financial position either. It too would evaporate.
@Lottoisfun said “Your premise really depends on how much debt is causing bankruptcy, doesn’t it? Even if you make very wise decisions, if you get hit with 40K in medical bills at the same time you are out of work I’m not sure that having a paid off car is going to help you avoid bankruptcy.”
The debt is not the problem but merely the symptom of their habitual spending tomorrow’s money today and having little to nothing saved for the future.
The typical American household can easily spend in excess of $1000 monthly on student loans, car notes, credit card debts etc. If these winners became debt free with their winnings then committed to saving $1500 a month for 1 year to build an emergency fund, after 1 year, they would have $18,000. Then if the lost their jobs and had a $40K medical bill, they’re not bankrupt just without any income. Those are two different things. (they would only be bankrupt if 1) the medical office decided to sue, 2) won the judgement (which the would), 3)decided to execute the judgement (which typically takes them a long time to get around to doing)
More importantly, the medical office will likely be willing to negotiate in this situation (either reasonable payments or a settlement). They routinely give lots of grace provided that you are upfront with them. It’s part of the charitable nature of many practices (not all of them, but many).
Additionally, this assumes that these winners have $0 savings to begin with, no equity in their home, and practically nothing that they could sell to generate some rapid income, plus a job loss and a huge sickness. Thus, this is pretty extreme, so I do feel most people would be in a better position and if they made wise choices would not be going bankrupt, especially after a sizable influx of cash.
@Lottoisfun “Your premise really depends on how much debt is causing bankruptcy, doesn’t it? Even if you make very wise decisions, if you get hit with 40K in medical bills at the same time you are out of work I’m not sure that having a paid off car is going to help you avoid bankruptcy.”
The debt is not the problem but merely the symptom of their habitual spending tomorrow’s money today and having little to nothing saved for the future.
The typical American household can easily spend in excess of $1000 monthly on student loans, car notes, credit card debts etc. If these winners became debt free with their winnings then committed to saving $1500 a month for 1 year to build an emergency fund, after 1 year, they would have $18,000. Then if the lost their jobs and had a $40K medical bill, they’re not bankrupt just without any income. Those are two different things. (they would only be bankrupt if 1) the medical office decided to sue, 2) won the judgement (which the would), 3)decided to execute the judgement (which typically takes them a long time to get around to doing)
More importantly, the medical office will likely be willing to negotiate in this situation (either reasonable payments or a settlement). They routinely give lots of grace provided that you are upfront with them. It’s part of the charitable nature of many practices (not all of them, but many).
Additionally, this assumes that these winners have $0 savings to begin with, no equity in their home, and practically nothing that they could sell to generate some rapid income, plus a job loss and a huge sickness. Thus, this is pretty extreme, so I do feel most people would be in a better position and if they made wise choices would not be going bankrupt, especially after a sizable influx of cash.
@ Lottoisfun: “However, if you think about it as a *consumption* good, it is actually a very wise decision. If lottery tickets are replacing dollars that you otherwise would have spent on candy, sodas, or God forbid cigarettes, choosing the lottery instead is actually very wise.”
Talk about mental accounting. The fact is that, rather than spending the money, if you took your candy , soda, and cigarette money and invested it or even just dropped it in the bank and let it sit it would in all likelihood be a better choice than buying a lottery ticket.
of course, if you really knew that that was your consumption money and it was unalterable then of course choosing to spend the lottery ticket over candy might be a better investment–but you’re giving up the definite pleasure of the candy for the highly unlikely result of winning the lottery.
@BG: I like your marginal probability approach to the lottery: buying ONE ticket when the jackpot is extremely high. You could say that it is basically going to be a net loss, but only on maybe $3 a year, with the offchance of a 2 Million dollar payout. The $3 a year won’t affect you at all negatively in any real sense, while still providing the (highly unlikely) chance at a large winning.
The problem with this is that with most people it will build a gambling attraction and habit.
I admit that I’ll buy ONE $1 lottery ticket, and only when the jackpot is ridiculously large: this is only 2-3 times a year when I notice it.
The odds of winning are infinitely greater between 1 ticket and 0 tickets.
The odds of winning are infinitesimally small between 2 tickets and 1 ticket, which is why I only buy one.
Lottery tickets are a tax on people bad at math.
Lottoisfun………I like candy, they taste good. The same with sodas. I enjoy every candy bar & soda I purchase. That’s my momentary pleasure, your words, not mine. I don’t smoke but I can imagine that smokers get some sort of momentary pleasure every time they light up. What momentary pleasure do you get when you scratch off that lottery ticket & lose……..again & again & again??
Or does the momentary pleasure come from the illusion that you might win big this time? Nevertheless I must thank you though for providing me the momentary pleasure of laughing my ass off when I read your comments.
@DanB I don’t think you can say that lottery players are stupid. The odds are really only terrible if you are thinking about the lottery as an *investment*. So if you are using dollars that you would otherwise invest, it is not a wise choice. However, if you think about it as a *consumption* good, it is actually a very wise decision. If lottery tickets are replacing dollars that you otherwise would have spent on candy, sodas, or God forbid cigarettes, choosing the lottery instead is actually very wise. Gives you the same momentary pleasure without the adverse health effects.
@Roshawn Watson Thanks for replying to my comment! Your premise really depends on how much debt is causing bankruptcy, doesn’t it? Even if you make very wise decisions, if you get hit with 40K in medical bills at the same time you are out of work I’m not sure that having a paid off car is going to help you avoid bankruptcy.
It’s an illuminating study only in the context that it describes the behavior of a subset of people who are stupid enough to play the lottery in the first place. In terms of pure odds, it’s by far the worst financial proposition out there. Do we expect a group which makes such decisions to become savvy in any manner………especially after suddenly experiencing such tremendous luck? And in effect having their behavior validated because they won? I mean please!
I’d like to know what percentage of these winners end up tossing all their winnings back into lottery tickets over the following years. That should be an interesting number.
@BG
I’m sorry to hear that. Thanks for letting us know though!
Looks like that simulator has been hacked?
“In the 36998907 times this simulation has run, players have won $64714243
And by won I mean they have won back $64714243 of the $36998907 they spent (174%).”
lol
Only the latter: it says nothing about their incidence of filing bankruptcy compared to the general population.
Does the study show that lottery winners are more, less, or equally likely to declare bankruptcy as their non-winning peers? Or just that the size of the win doesn’t affect the probability?
@John Fabulous points.
One thought, I suspect people requesting handouts and pressure for conspicuous lifestyle inflation are likely part of the basis for an increasing number of winners sending an agent (i.e. lawyer) to collect their winnings anonymously.
Thanks for the comment!
Despite the tax implications of lottery winnings, the article’s point stands. Statistics being what they are, I agree that a sudden windfall is often lost. Winning less than $10,000 really shouldn’t have a major effect on a person’s lifetime financial goals. If you suddenly have more money and people know it, everyone is going to ask what you are doing with it, and you better have some good answers that aren’t boring. Immediate lifestyle inflation occurs, and most people are unable to reverse that phenomenon after the new money is gone and the same old income has to suffice.
The good ol Cheshire Cat knew why lottery winners and inheritors have such a rough track-record. If you don’t know where you want to get, then it doesn’t matter which way you go. If you don’t use free money to advance your financial goals, then whatever you spend the free money on will start feeding on your usual cash flow soon enough.
By the way the article will appear in a forthcoming issue of the Review of Economics and Statistics.
@lottoisfun Great comment! Unfortunately, the article isn’t out yet, and the article summary doesn’t distinguish between net and gross winnings. I would suspect it is gross. I get your point that $25,000-$75,000 after taxes is definitely cut down substantially after taxes.
One thing to also consider is that if an indebted person’s winnings were say a net of $37,500 (half of $75,000) and he used that money to pay off all his student loans and car, his life could easily be changed because he could be debt-free (excluding the house) or near debt-free. Consequently, even during a disaster, he might not be bankrupted if he acted so responsibly.
In contrast, some probably used the money to get into even larger financial binds than before they won the lottery (i.e. financing a $40,000 BMW).
The impact of choices is significant here. Overall, if the median net worth was approximately $91,304 (in 2009), and someone nets a quarter of that without significantly changing his or her financial position, it is quite sad in most cases. There are certainly exceptions though. Thanks for your insightful comment! I really appreciate it.
Are the amounts won gross or net? Winning this amount in the lottery would put you at the highest marginal tax rate – for my state that means 50% (38 federal 12 state). So, these winners got from 25,000 to 75,000. Nice, but hardly life-changing. And, if you believe Elizabeth Warren the chief causes of bankruptcy are medical bills and divorce. A serious medical problem would eat up 25,000 in no time.