Wheel of Fortune

October 2010, Business2Business

Recently the biggest Lotto Powerball prize in NZ Lotteries’ history was claimed, earning the ticket holder a massive $28.7 million in prize money.

Lotto is a gamble and despite the remote chance of winning, it doesn’t stop Kiwi’s from queuing up to buy a ticket. Whilst most people treat this “gamble” as pure entertainment, excitement, or even the thrill of the chase to “win the big one”, those same attitudes are often bought to the stock market with disastrous results.

Investment and gambling both involve taking a risk. The difference is that gambling almost always means taking avoidable risks unrelated to the potential return as there is no net benefit to the player and the odds are with “the house”.

By contrast, capital markets have a history of rewarding investors for the capital they supply, but this is a long-term activity and one that should be undertaken after receiving financial advice. It requires an understanding of risk, a willingness to diversify and the exercise of discipline.

Regrettably, many people see little distinction between gambling and investment as revealed in the results of a new study.

Two researchers from the University of Hong Kong carried out a study of lottery and stock market behaviour in Taiwan. They chose Taiwan because apart from the public lottery, other forms of gambling are prohibited and 70% of the trading in that country’s stock market originates from individual investors.

Using data collected from January 2002 to December 2009, the researchers established the effect of the lottery on stock market trading was pronounced among the sorts of stocks favoured by individual investors. These tended to be small cap stocks with high past returns and high turnover.

Specifically, the Taiwan study found that trading of highly volatile stocks noticeably dropped on days when the lottery was offering a jackpot, with a direct correlation between the jackpot size and the quantum of the reduction in trading. This would indicate many investors saw the entertainment effect of the lottery as a direct substitute for how they viewed shares.

“Rather than changing the mood of investors, a large jackpot satisfies investor needs and caters to preferences that are similar to stock trading,” the paper concludes. “Therefore, a lottery with a large jackpot can affect investor trading activities in certain segments of the stock market.”

It is understandable that thrill seeking and entertainment should be a primary motivation for people taking part in jackpot lotteries. While the odds are clearly against the gambler, people often take part for the sheer fun of it and the social benefit of being “part of the game”.

Bringing those motivations to the share market in the name of investment is not wise, as you need to receive sound advice and be prepared to maintain discipline, knowing a long-term payoff is on offer for those who build diversified strategies around risks related to return.

This is not gambling.