Why the share market beats lotto hands down

I have never really understood the attraction of lotto.

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

Recent moves by the Victorian Government to cynically increase how many numbers are used in Keno demonstrate the problem of relying on winning the lottery.

Chances of a lotto win keep falling

The chances of a win have now blown out from an extraordinary 1 in 45,379,620 to a stellar 1 in 62,891,499.

It is still a great deal for the state government, with bigger jackpots and extra tax revenue set to flow in, but it is a terrible idea for the hapless punters, whose chances of a win are now so remote as to be almost negligible.

Contrast the odd of winning the lottery to the chances of being hit by lightning – somewhere around one in 12,000 – and you can clearly see that the dream of a lotto win is really an expensive mirage.

However, if the punting urge is strong and alternative betting options with better odds of success and lower levels of tax don’t appeal, there is always the share market as an alternative.

Is the share market really more dangerous?

Usually, those people who religiously take out lotto tickets are the same ones who warn that the share market is “too dangerous” and “might crash” but lets for a moment consider a form of alternative share market lotto.

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

However, on the share market it is much less common for investments to fall to zero so already you should be well ahead by switching from lotto to the share market.

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

You can increase potential returns in a concentrated portfolio

However, this time we are not talking about the usual plan to gradually grow wealth over time but to knock the lights out with a more remote but more exciting plan – more of a punt or a gamble if you will.

Interestingly, there is some numerical support for such an approach, likely driven by the fact that smaller companies – while riskier – can grow much more quickly than big companies.

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

That seems somewhat contrary to the data that shows that in 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 the most likely culprit for the underperformance.

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

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

It makes some sense when you think about it – there are thousands of small stocks outside the big indexes so if you randomise your stock selection, you are likely to get more of these little companies.

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

Time to break out the dartboard

Which brings us to the design of your customised stock market lotto machine which will hopefully increase your chances of “a win” compared to filling the state government coffers with undeserved taxes.

There are obviously electronic ways to randomly pick a listed company to invest in but the timed honoured way of randomising stock selection is to use a newspaper share list and a dartboard.

At least that way you can point to some element of luck or even skill in your eventual outcome.

There is also an element of education in this version of share lotto – you can learn about some interesting companies that you hit with a dart that you might not have otherwise ever come across.

Separate a game from real investing

Just a final word of warning about playing share lotto – a game which is virtually guaranteed to increase your chances of a positive result compared to buying lotto tickets.

It is obviously just a fun addition to an otherwise sensible investment strategy and in no way a replacement.

With small purchases – say a share lotto game every month – it will also be important to keep brokerage to a minimum to try to get as many shares as you can for a small amount.

After a while though, share lotto could be almost as fast as buying a lotto ticket online or walking down to the newsagent and much more fun.

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