If you had some money every month, what would it go: a more comprehensive insurance plan, or into something like 4D or Toto? Now I’d hope the immediate response among most people is insurance, because that’s generally the sanest response. However, there are a couple of ways to think about, which reflect on issues like your risk appetite, and how your financial experiences have shaped you. Take a moment to think about this:
The superficial resemblances between the lottery, and insurance
To the less financially literate, the two look more similar than you might expect. With the lottery, you put in a small amount of money (less than the amount you could potentially win), for a shot at getting a big payout.
With insurance, you also put in a smaller amount of money than you could potentially get back (premiums versus payout).
And on top of this, the lottery is a much more entertaining and cheerful prospect, as you’re not getting the payout for losing a limb, getting cancer, your house catching fire, etc. So if you were to present the two options – lottery versus insurance – to someone with little or no grasp of finance, you can probably see why the lottery may look comparable or even more attractive.
However, as a financially savvy sort, you know you’re supposed to say insurance is the right answer. The question is, why? Being able to answer this question is an important exercise in financial literacy, as it breaks down your perspective of risk.
Key considerations in your answer
Some of the factors to get you thinking are:
- Poverty and affordability
- Immediacy of returns
- The guarantee of mortality
- “Winning by not losing” as a valid life strategy
1. Poverty and affordability
Ever wondered why the poor tend to buy the lottery more often, even if they know insurance is the “proper” choice? Forget condescending statements like “the lottery is a tax on the poor.” If you’re in their position, the situation can look wildly different.
A 4D ticket can cost as little as $1, although the bigger gamblers might be buying $50 tickets. Conversely, an insurance policy – especially if they’re older and in poor health – may be upward of $300 or $400 a month.
For someone who’s earning very little – say $1,200 a month or less – there may only be $50 to $100 left for discretionary spending, after food and lodging; sometimes even less. Since they can’t afford better insurance with that anyway, the theory is they may as well put it in 4D or Toto. That way, they might at least have a chance to break out of their cycle of poverty.
To be clear, they’re not correct.
They should be saving the money for emergencies, topping up their CPF, etc. as a safe way to hopefully better their situation (some might argue that’s also a more reliable way). But the point here is how, from the perspective of the desperate, risk tolerance can actually increase rather than decrease.
When there’s a sense that you have nothing left to lose, or that you have no other options, recklessness sets in. While we hope none of our struggling single digit millionaires ever fall into dire straits, do remember this if your finances head south: resist the temptation to make big bets to try and restore your wealth ASAP.
Reckless risks look deceptively reasonable, when you’re in a position of financial insecurity.
2. Immediacy of returns
How quickly do you need your payout? Most insurance policies – particularly those with a savings component – take years of premium payments before you hit the big payoff. With the lottery, the temptation comes from the immediacy of the payout.
We all understand the desire for quicker returns, and the time value of money: a million dollars today is worth more than a million dollars in 10 years. But this where age, and the available investment horizon, starts to kick in.
For someone who starts saving for retirement late, there’s a much shorter runway; and for those who had different opportunities in life (e.g., they only started to make $3,000 a month once they hit their 50s), you can probably see how the lottery looks like a better deal.
This can also happen to single digit millionaires who have bigger financial needs, but short horizons. For example, someone with only $1 million at age 60, but is still off from retirement targets by $500,000 (that’s not necessarily due to greed – it can arise from a need to look after family members with special needs, for example).
But again, it’s a wrong decision, as the lottery doesn’t carry any certainty of a payout (in fact, the chances of winning are quite slim). An insurance plan with a proper savings / investing component might mean you need to work a little longer; perhaps even unto your 70s, but at least there’s a guarantee of something at the end of it.
3. The guarantee of mortality
This is probably the biggest difference between life and health insurance, specifically, and the lottery.
It’s possible that you will never get the payout or benefits from the lottery. In fact, this is the norm: most people go through life without ever winning the 4D or Toto first prize; or at least, winning such a large amount that they’re financially free.
With life and health insurance however, some kind of payout is guaranteed. There’s a 100 per cent probability that, at some point in your life, you’re going to be sick, injured, or die. As morbid as it sounds, life or health insurance has a perfect “win” rate.
In a perspective on risk, that makes it a better deal than the lottery.
4. “Winning by not losing” as a valid life strategy
If you don’t buy the lottery – and hence don’t win the lottery – your life continues as it does now. But if you don’t buy insurance, and you’re medically unable to work, can’t pay liability costs, etc., your life becomes much worse. In this sense, opting for insurance over the lottery becomes a “winning by not losing” strategy.
And that’s an important concept to grasp in investing as well.
If you have $3 million, you may have the option to invest in higher-risk, higher-return products. Quite often, you’ll be pushed to. But go back to the “winning by not losing” idea:
In general, if your investments at least keep pace with inflation, you won’t be crushed by losing one percentage point in your returns. If you don’t take a big gamble and don’t reach billionaire status: that’s probably something you can probably survive. What you might not survive is losing half of a $3 million portfolio.
So if “insurance beats the lottery” seems like a common sense answer to you – and it is – don’t lose sight of the same principles when you invest.
Don’t let the same concepts of risk management and realistic goal setting fly out the window, just because an exotic investment sounds better than buying the lottery (but is functionally the same).
For a more safe and grounded approach, as more investment opportunities open up to you, follow us on Single Digit Millionaire.
