The lottery: An 'investment' for fools

Updated March 30, 2012, 2:04 p.m. ET

This post comes from J.D. Roth at partner site Get Rich Slowly.

Over the years, I've done some foolish things with my finances. I've squandered money on comic books. I've speculated on risky stocks, hoping to make a quick fortune. I've paid a gazillion dollars -- or something close to it -- in credit card interest and bank fees. I spent large windfalls on the latest technological gadgets.

No, I'm by no means perfect with money.

One trap I've managed to avoid, though, is the lottery. Playing the lottery has never tempted me. Maybe it's because I know the odds are always overwhelmingly stacked against the player -- I know I can't win the lottery, so why bother?

Caveat: That's not to say I've never played the lottery. I used to play Sports Action, Oregon's NFL-based betting game, once in a while. And I've bought an occasional scratch-off ticket. But when I do these things, I consider them one-time entertainment expenses, not paths to riches.

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A fool and his money . . .

Not everyone is so lucky. For some, gambling is an addiction. It may start as innocent fun, but it grows beyond that, becomes a financial funnel, draining dollars from their daily lives. And some in dire financial straits may actually view the lottery as an investment strategy!

According to Wired magazine:

While approximately half of Americans buy at least one lottery ticket at some point, the vast majority of tickets are purchased by about 20 percent of the population. These high-frequency players tend to be poor and uneducated, which is why critics refer to lotteries as a regressive tax. (In a 2006 survey, 30 percent of people without a high school degree said that playing the lottery was a wealth-building strategy.) On average, households that make less than $12,400 a year spend 5 percent of their income on lotteries -- a source of hope for just a few bucks a throw.

Just how foolish is it to play the lottery? It depends on the game you play, of course. I once calculated that for every buck my brother spent on a scratch-off game, he could expect to get roughly 50 cents in return. (That's if he bought a bunch of tickets, of course. If you buy only a few, anything can happen.)

It's even more depressing to take a look at the odds for lottery drawings. Here, for instance, are the odds of winning the Mega Millions lottery. They're not good. You have about a 1 in 40 chance of winning something. Your odds of winning the big jackpot (by matching the five main numbers and the bonus number) are roughly 1 in 175 million.

But that's pretty tough to visualize, right? I mean, 175 million is a big number. No worries! Rob Cockerham at Cockeyed.com whipped up a little widget that lets you simulate the Mega Millions lottery. This is a great way to see just how fruitless the lottery is. (Post continues below.)

Better bets
Almost anything is a better "investment" than flushing your money down the lottery toilet. In his book "Stocks for the Long Run," Jeremy Siegel crunched the numbers to find the historical performance of several common investments. The results? Since 1926:

• Gold has a real return (meaning "after-inflation return") of about 1%.
• By my calculations (not Siegel's), real estate also has a real return of about 1%.
• Bonds have returned about 5%, or about 2.4% after inflation.
• Stocks have returned an average of about 10% per year and a real return (or inflation-adjusted return) of about 6.8%.

These options are volatile, of course, meaning the returns one year can be negative (though not nearly as bad as playing the lottery), and the returns the next can be positive. If you're looking for a "sure thing," you're left with so-called safe investments, such as savings accounts and certificates of deposit.

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Savings accounts and CDs have paltry returns right now, but they're sure to rise as the economy improves. And even a 1% interest rate crushes a continuing 88.9% loss on your money. (Not to mention that the lottery numbers I calculated above don't factor in inflation.)

Note: I can't find any data on the relationship between savings-account interest and inflation. If I had to make an educated guess, I'd say that savings accounts return about 1% more than inflation every year, meaning that they're on a par with gold or real estate in the long term. But this is just a guess!

Let's assume you inherit $100,000 and want to invest it. Let's also assume that you're going to put it in one investment vehicle and leave it there for 30 years. (And that your returns on this investment will compound monthly.)

• If you invested in gold or real estate (or a savings account), you might expect to have about $135,000 after inflation.
• If you invested in bonds, you'd probably have about $200,000 after inflation.
• If you invested in stocks, you could have more than $750,000.
• But if you "invested" in the lottery, you'd have nothing. After 10 years, you'd have just 10 bucks left. After 17 years, you'd have a penny -- which you'd promptly lose. And again, the numbers for the lottery don't factor in inflation.

So, if you really want to strike it rich, don't play the lottery. Do something boring with your money. Take advantage of the extraordinary power of compound interest to get rich slowly. If you don't have a Roth IRA, start one. Use it to buy indexed mutual funds. If that sounds too complicated for you, then open a savings account.

• How do your finances stack up?

There's no question: Playing the lottery as a strategy to gain money is a fool's game. Play the lottery for fun if you want, but don't do it because you think it's going to help your financial situation.

Bitter irony

Many folks win big jackpots, only to lose the money -- or their happiness. People are fools to play the lottery, and they often remain fools after winning. Some examples:

• Money UK: "How the lives of 10 lottery millionaires went disastrously wrong."
• USA Today: "Lottery winners' good luck can go bad fast."
• The Lotto Report: "Sad but true" Lotto winners' stories.

A 2001 article in The American Economic Review found that after receiving half their jackpots, typical lottery winners had put only about 16% of that money into savings. It's estimated that more than a quarter of lottery winners go bankrupt. Take Bud Post: He won $16.2 million in 1988. When he died in 2006, Post was living on a $450 monthly disability check. "I was much happier when I was broke," he's reported to have said.

Even when they win, lottery winners often lose.

More from Get Rich Slowly and MSN Money:

• 27 frugal uses for a dead phone book

• What is a Roth IRA? A short and simple guide

• How much do you spend on kids?

• How to invest your Mega-Millions

• Mega Millions office pool? Be careful 
• You won the lottery! Now what?