How You Know Just How Bad the Economy’s Gotten
Posted on October 10, 2008 Posted by John Scalzi 29 Comments
For the first time anyone can remember, a Michigan Mega Millions lottery winner has voluntarily chosen the “annuity” option, rather than taking the lump sum and hoping to make a killing off of it through investments.
It’s madness out there! Madness!
That person is an idiot. If anything, right now is an even better time to take the lump-sum and invest it since a lot of stocks are well below their true value. The annuity is almost certainly going to diminish in value with each payment…
On pure economic grounds I think you have a reasonable argument, but there’s also the other issue, which is that historically, lottery winners are terrible money managers, and a whole lot of them end up losing all their winnings in relatively short order due to bad investments, ill-advised spending and so on. It’s not that they’re stupid, necessarily, it’s that managing money is in fact an actual skill. Someone with no money management skills is probably better off with an annuity; that way if they mess up early they still have some money.
Even so, the market conditions right now are being driven primarily by panic, and at some point there will be a rebound. I would always prefer the lump-sum over the annuity, but even more so today.
Someone with no money management skills is better off hiring a reputable person to manage it for them. The annuity is better than nothing, as long as you realize that by the end it will be worth far less than when you started.
John H:
“Someone with no money management skills is better off hiring a reputable person to manage it for them.”
Oh, I agree entirely. It’s a shame so many lottery winners don’t, and end up losing it all.
We’re not really having a disagreement here, I think; just coming at it from different points.
Yeah, so, probably not a bad choice for someone who isn’t quite up to speed on finances. At 42 mil, they are probably going to see around 1 mil per year after taxes for 30 years.
Rough life. To bad they didn’t take the lump sum… I feel for them.
Oh, how I would love the chance to prove my money-management skills.
Most lottery winners prefer to invest their lump sum payment in traditional high-yielding investments such as commodities (bulk cocaine purchases, bling) and associated service industries (gambling, entourage maintenance, and certain other adult services). Almost anyone can become an expert in this form of money management.
I love how the three bullet points of the “story highlights” are almost as long as the six-sentence story itself.
Third “story highlight”:
• Confidence in the market has dropped due to financial crisis
Well, at today’s prices, the $21M he’d get in lump sum (I’m assuming like most of these, the lump sum is half the full payout), could be enough to buy a major financial institution.
But that means he’d be expecting that financial institution to have people with money management skills, something not particularly evident right now, especially the ones you could buy for $21M.
Why would anyone want to buy a major financial institution? It’s not like they have money in them.
Madness? MADNESS? THIS… IS… AMERICA!
*kicks lottery winner into the Pit of Death*
Scalzi: We’re not really having a disagreement here, I think
Agreed…
@ Scalzi @ 2:
People who win huge tort lawsuits for injuries are exactly the same way. That’s why these multi-million dollar settlements are all structured as annuities – so people don’t blow a lifetime’s worth of money needed for medical care on a new Ferrari. Plus, the defendant’s payout is usually lower in the long run. Everybody wins.
Which is why my tort law professor thinks those J.G. Wentworth that you see on TV promising quick cash in exchange for all the future annuity funds are crooks.
Given the economy, it’s more likely that Michigan will run out of money before they pay off the annuity. Take the lump sum.
I have heard that the “full” amount is actually the expected yield of a long-term investment, and that you win a share of that long-term investment. I am pretty sure this is true.
I have also heard lump sum payment is actually taxed as if it were the full amount won, and the amount of the remaining investment is essentially the regressed interest calculation off the full amount, from which the taxes are paid and then the remaining investment is paid to the winner.
I have no idea if this is true or if they only tax you on what you really receive.
Now is a great time to have a lump-sum to buy an island with good fishing and fresh water. Maybe even not fresh water, just a good reverse-osmosis filter and some large cisterns.
And a treasure chest. To bury the booty, of course. Well, that assumes that you bring your booty to the island, which, I think, is the recommended course of action.
I would happily take annuity over a lump sum. Means I’d have less of a chance to blow all my money and more time to figure out what I want to do with it all.
Of course, if I wanted that, I’d actually have to play the lottery…
Sarah @ 17: My feeling is that you hardly reduce your chances of winning at all if you don’t play the lottery.
Basic supposition: you’ve got, say, a 1 in 1,000,000 chance to get a major payout of the lottery if you’re a lifetime, devoted player.
If you’re not a player, you could still find a winning ticket on the street, or be given a ticket for a birthday, or whatever. Let’s say that that makes your lifetime odds of winning 1 in 10,000,000,000.
Your odds, then, are only 0.9999 in 1,000,000 worse if you aren’t a player than if you are! That’s hardly any difference! Like, would you care if on a coin flip, the odds weren’t 50-50 in your favor, but rather 50.000001%? Not a lot.
I think the reason for this is how the lottery system funds lump sum payments. They issue a bond to cover twenty years of repayments and the value of that bond is given to the winner. Given the turmoil on Wall Street and the inability of players like the State of California to issue bonds, I bet that the winner of the lottery was offered an insanely small amount as his lump sum winning. He had no choice but to take the annuities.
I’d take the lump sum and invest it in something that had a prayer of keeping ahead of inflation. What’s the purchasing power of that annuity going to be like in ten years?
“historically, lottery winners are terrible money managers”
Heh. Buying lottery tickets is a terrible choice of investments.
The fact that they based their decision on the current economy is evidence that they made the right choice – that’s short term, emotionally based decision making.
Personally, if it was a large lottery (giving me 20m or more as a lump sum), I’d take the lump sum, break off enough into investments that, if it’s a T-Bill return I can live on the return, and then pause. I may well splurge some in the first year – that’s part of the attraction of a lottery after all. But I’d only do it with money outside of the lump sum and I wouldn’t blow it all. In fact, after an initial splurge (buying a nice penthouse condo in downtown Seattle perhaps, traveling for a year or so), I’d very likely setup a foundation and run that. After all, if I’m set for life… and I’ve got millions… why not use the cash I don’t need to help others?
I don’t play the lottery, and I really have no idea how these things are structured, but I’d assume that, with a jackpot of $42 mil, the annuity would be at least a million a year for, what, twenty years? Honest, kids, $1,000,000 a year is *plenty* to live on, with lots left over to invest, give away, etc. And if you manage to screw up big time through lack of experience handling large sums — there’s another million coming in next year, aka a safety net.
R. W. Ridley @14 If things get bad enough that the State of Michigan goes bankrupt, I doubt that any of the lump sum investments would still be viable.
R.W. Ridley:
Speaking as someone who once administered a contest with a million dollar payout, I can say the annuity is generated by an already-existing sum; i.e., the money is there and not dependent on the liquidity of the state.
While I haven’t played with the numbers for a while, I’m amused by all the insistence that the annuity is an awful, awful decision.
Would you rather let the money grow tax-free for up to 20-30 years (depending on lottery), or get it all taxed up-front, and then have any growth taxed as well?
Yes, you can beat the returns on bonds. But can you do it consistently? After tax? When you’ve lost between a third and half of the seed cash to taxes before you start?
Hmmm….
My living expenses are only about $20k per year, so to me, anything beyond that would just be gravy. I’m not sure I’d necessarily care how much I lost in taxes – as long as I could continue to live well and donate to all the charities I wanted.
I wonder how much I’d have to win to generate $20k in yearly interest…
BradJ:
But that logic only works if it is growing at the interest rate of a bond while in the Lottery Commission’s hands. Some lotteries may work that way, maybe the one you’re most familiar with, but most I know of simply pay out the initial amount over time. It’s like money under a mattress; negative real growth.
Of course lottery winners are terrible with money. They PLAY THE LOTTERY.
@ Rick
The problem with putting a lottery lump sum into T-bills right now is you would essentially be earning 0%. Everyone has rushed into T-bills for safety and driven up the price enough to cancel out the 3-4% interest.
The lump sum is better considering all factors (returns, taxes, etc.) if you have average money management skills. However, as the recent financial debacle has shown, the majority of people can’t even spell money management. An ARM loan…really? So, they are probably better off taking the annuity, though they will still need to invest some of it if they are young enuogh.