Why the stock market hands down the lottery

I never really understood the appeal of the lotto.

It seems to be based on a “dream” of a small investment suddenly bringing in untold, life-changing riches, but the reality of lotto is actually closer to throwing money off a cliff and hoping in find more at the end of a rainbow.

The recent moves by the Victorian government to cynically increase the number of numbers used in Keno demonstrate the problem of relying on winning the lottery.

Odds of winning the lottery continue to decline

The odds of winning have now gone from an extraordinary 1 in 45,379,620 to a stellar 1 in 62,891,499.

That’s still a lot for the state government, with bigger jackpots and extra tax revenue, but it’s a terrible idea for the unfortunate bettors, whose odds of winning are now so remote they’re almost negligible.

Compare the odds of winning the lottery to the odds of being struck by lightning – about one in 12,000 – and you can clearly see that dreaming of winning the lotto is truly an expensive mirage.

However, if the urge to roll is strong and alternative betting options with better odds of success and lower levels of taxation don’t appeal to you, there is always the stock market as an alternative.

Is the stock market really more dangerous?

Usually those who take lotto tickets religiously are the same ones who warn that the stock market is “too dangerous” and “could crash”, but let’s consider an alternative form of lotto for a moment.

In a normal lotto, if you lose, you lose everything – rinse and repeat.

However, in the stock market it is much less common for investments to drop to zero, so you should already be well ahead of the game when switching from the lotto to the stock market.

Now normally I would say look for a conservative strategy such as gradually building up a stake in an exchange-traded fund (ETF) such as State Street’s ASX 200 fund (ASX:STW) or a locally listed US equivalent like the State Street ETF’s S&P 500 (ASX:IVV) or even a listed local investment company like the Australian Foundation (ASX:AFI).

You can increase potential returns in a concentrated portfolio

However, this time we’re not talking about the usual plan to gradually build wealth over time, but to turn off the lights with a more distant but more exciting plan – plus a punt or a bet if you will.

Interestingly, there is some digital support for such an approach, likely driven by the fact that small businesses – while riskier – can grow much faster than larger companies.

According to research by US portfolio manager and author Robert Hagstrom, a high-conviction stock portfolio can actually increase your chances of outperformance.

This seems somewhat contrary to data which shows that over the long term, the majority of active managers underperform their benchmarks.

Over a decade, 79.8% of active funds underperformed the ASX 200, with fees most likely responsible for the underperformance.

However, Hagstrom found that a randomly generated portfolio of 15 stocks would generate a maximum return of 26.6% per year over a 10-year period.

This fell to 19.2% for 50 stocks and for portfolios that included 250 stocks, the best possible return was 16% per year.

It makes sense when you think about it – there are thousands of small stocks outside of the big indices, so if you randomize your stock selection, you’re likely to get more of those small companies.

Thus, the maximum “speed limit” of your randomly selected portfolio should increase – along with the risk.

It’s time to break out the dart board

Which brings us to designing your own custom stock market lotto machine that will hopefully increase your chances of “winning” versus filling state government coffers with undeserved taxes.

There are obviously electronic ways to randomly choose a publicly traded company to invest in, but the most expedient way to randomly pick stocks is to use a newspaper stock list and a dart board.

At least this way you can indicate an element of luck or even skill in your final result.

There’s also an education element to this version of shared lotto – you can learn about some interesting companies you hit with a dart that you might never have come across otherwise.

Separate a game from a real investment

Just a final word of warning about the shared lotto game – a game that is virtually guaranteed to increase your chances of a positive outcome over buying lotto tickets.

This is obviously just a fun addition to an otherwise sensible investment strategy and by no means a replacement.

With small purchases – say a stock lotto game every month – it will also be important to keep the brokerage to a minimum to try and get as much stock as possible for a small amount.

After a while, splitting the lotto could be almost as quick as buying a lotto ticket online or going to the newsagent and way more fun.

Good luck and remember, even if you lose there is a nice consolation prize because Dan Andrews also lost!!!!