Asset Allocation

It is often the ‘old-school’ print advertising that draws me in. This week, the newsagents are at it again, spruiking lotto tickets for the Powerball: “$100 MILLION JACKPOT.” As a consistent participant in the bigger lotto draws, technology advancements mean that I now also receive all sorts of targeted marketing including emails, Google ads, and posts on my Facebook newsfeed.

Who wouldn’t want to win that kind of money?

Hey, I’m not greedy – I’d settle for just 1/100th of it. A cool $1 million, what a boost to the retirement fund that would be! And everyone has their ‘number’… meaning the amount of dough you would need to quit your job on the spot and enjoy an early retirement. Let’s just say $100 million is well above my ‘number.’ Some say retirement is the #1 cause of death. I will take my chances.

So, I went for it. It has to be my lucky day, right?

Ahead of me at the counter was another lottery player, clearly with his eye on the loot. The man bought tickets worth nearly $60. For sure, he had a better chance of winning than I did with my basic $5 ticket but, in truth, the odds were against us both. The chances of winning a lottery jackpot vary somewhat depending on the particular game, but are typically between 100 million to 300 million to one. Best not give up my day job, just yet.

The man eagerly handing over $60 to play made me wonder how many Australians ‘invest’ this kind of money every week in pursuit of big prizes and a possible fast track to retirement. Sixty dollars a week is around $260 per month, or more than $3,000 per year. That’s a lot to spend on something where the odds are so heavily stacked against you.

As opposed to the lotto, a true investment – you know, one where you actually own assets – typically generates positive returns over longer time periods. And the general rules of investing remarkably hold up well over time. For example: more risk, more return; there ain’t no such thing as a free lunch; the magic of compound interest, etc. So, let’s run the numbers…

Instead of ‘investing’ in the lotto every week, let’s assume a 25-year old puts aside $60 a week and invests that money on a monthly basis with contributions of $260 until their retirement, aged 65. Over those 40 years, the 480 monthly contributions of $260 would add up to nearly $125,000; the blue line on the chart.

Stylised example: compounding - the key to a comfortable retirement?

Next, let’s assume that money is invested in a basic balanced fund (70% growth, 30% defensive) that’s invested across a diverse range of financial markets and generates an average annual return of 7% after fees and charges. This is a ballpark long-term estimate targeted by most money managers in these products. It’s also one that has historically been validated. 

If the average annual 7% net return is achieved, after the 40 years the saver would be sitting on a nest egg of around $680,000; the green line on the chart. The saver isn’t quite a millionaire, but they’re nearly 70% of the way there. And with average superannuation balances currently around the $300,000 mark, with some sensible financial decision making and regular contributions, that magic million might be more attainable than many people realise. Now, that’s some serious cheddar!

Simulations like this come with various caveats and disclaimers. We know that past performance is no indication of future results and that assumed investment rates of return will affect the size of a savings balance over time. Inflation will erode the purchasing power of the final lump sum too. And as Yogi Berra put it, “The future ain’t what it used to be.” This may bode poorly for investment returns in the period ahead given current valuations across asset classes. Finally, who knows many 25-year olds that are thinking about sensible retirement planning? Nonetheless, the exercise highlights the power of compounding and how it can affect wealth accumulation over the long term.

So, when I pony up for those lotto tickets I’m doing it with the full knowledge that it’s a horrible ‘investment’ and instead should be thinking about the real factors impacting long-term wealth accumulation. In order of importance, these are:

  1. The amount you save
  2. When you start saving;
  3. Your asset allocation; and
  4. Your achieved return, including above or below the market average.

You know what, with the benefits of a regular savings plan and the potential for a secure retirement, perhaps we can all afford to play the lottery now and again. The chances are you won’t win it, but it doesn’t hurt to dream once in a while. Good luck!

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Comments

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Jeremy Law

Great article mate, always a good reminder!

Wayne Terry

Completely agree. Much better uses for ones money. I rarely play the lotto, powerball, OZ lotto etc. as the odds are ridiculous - especially powerball last time I checked. But I must admit, I do play the old school lotteries several times a year when the jackpot is at least a few million... I believe the odds are better on these and, if you win, you win the lot - no sharing! Old mate in Chatswood won $96.4 mil a few weeks ago on the $5 lottery, and that's on top of his minor prize of $100 the cheeky bugger. But until then the focus is on investments and super. Perhaps should buy some Tatts stock.

Ninus Kanna

The odds of winning Powerball is 1 in 134.5 million. Multiplied by the cost of the game ($1.20) means its only rational to play if the jackpot is over $161 million -- and that's if it isn't shared! In which case, no return on $60 saved is still a better probability-weighted outcome!

Peter Just

These types of calculations are common and certainly show the power of compound interest. However, I have never seen any mention of the impact of tax and how that could impact the final balance. An additional caveat perhaps.

Carol Anderson

As they say - lotteries are for people who don't understand mathematics.

Stan Mc Donald

Richard,you have made a strong case to stop wasting your $5.;why do you do it ?