Riches to rags: Why most lottery winners end up broke

Here’s an experiment for you: Place a small bowl of M&Ms (or your fattening/sugary vice of choice) right within reach. Leave it there all day and then count how many you ate. Think that was a test of self-control? Now try putting a huge bowl in the same place. We’d venture to guess you’ll end the day with as few left at the bottom as when you started out with less.

Indeed, it’s hard to stop when it seems like you’re hardly making a dent. That’s because we tend to adjust our consumption based on what’s available to us – and we aren’t just talking about candy. Many people treat money the very same way.

From lottery to bankruptcy

According to a 2010 study by researchers at Vanderbilt University, the University of Kentucky and the University of Pittsburgh, the more money you win in the lottery, the more likely you are to end up bankrupt.

The authors divided past lottery winners into two separate groups: Those who had won cash prizes between $50,000 and $150,000, and those who had won $10,000 or less. What they found is that those who had won the more sizable sums were more likely to have filed for bankruptcy five years later. Similar research from the National Endowment for Financial Education estimates that 70 percent of people who had unexpectedly come into large sums of money ended up broke within seven years.

Now just imagine what millions could do…

Why we love the lottery

It’s thrilling to believe that a handful of numbers have the power to change your life. What else can you buy for a dollar or two that has the potential for that kind of return? It’s pretty seductive stuff. Plus, it’s a lot more fun to fantasize about winning big, than it is to think about some of the other things that are just as likely statistically (that would be getting struck by lightning or having identical quadruplets…in which case you’d really need to win the lottery).

Unfortunately, when it comes to buying a lottery ticket, our cost-benefit analysis tends to be a little off the mark. According to Statistics Canada, Canadians spend nearly $500 per year on lottery tickets, on average. While lower-income Canadians spend less than the average (about $235 per year), that expense makes up a considerably larger percentage of their income.

A 2008 study by researchers at Carnegie Mellon University examined why those with the lowest incomes in the United States tended to spend such a large percentage of their income on lottery tickets (up to 9 percent by some estimates). What they found was something called the “peanuts effect”. When participants were given a dollar at a time and asked whether they’d like to spend it on a lottery ticket, many more chose to do so than those in the other group, who were given $5 and asked if they’d like to spend it all on lottery tickets. In other words, some sums of money are so small that we tend to assume they don’t even count. This held true even for the poorest people in the study, many of whom got by on less than $15,000 per year.

[More: How to get rich slowly: The 3 most important factors in building wealth]

The problem is that whether you’re spending $200 or $500 on lottery tickets, it’s a lot to pay for a return that’s about as likely as giving birth to four babies (at once). If you invested that $200 per year at a modest 3 percent interest rate, you’d have $10,000 in 30 years. And while that’s certainly not a quick fix, it’s a sum most lottery players would be excited to win.

Why we ignore the odds

In major U.S. lotteries, the odds of winning a big jackpot are 1 in more than 100 million. In Canada, your odds are slightly better; the odds of winning the big prize in the Lotto 6/49, for example, are about 1 in 13 million. Those are pretty small odds, but that doesn’t prevent 25 percent of people on both sides of the border from playing weekly, even though most of us never win more than a free ticket.

So why do it? According to a 2012 survey by Capital One Canada and Credit Canada Debt Solutions, one-third of Canadians are banking on a huge jackpot as part of their long-term plan for financial success. Maybe there’s a debt to pay off and never enough money to do it. Maybe you need a job and haven’t been able to find one. Or maybe you have a job (but you hate it) and you’d rather spend the next 50 years lying on a beach somewhere. In other words, when reality gets too heavy to handle, we abdicate responsibility for our financial woes and wait to be rescued. We turn on the fantasy…

Why big winners end up broke

But let’s say you beat the odds; you avoid death by lightning and win a big jackpot! It could happen. It happened to a 35-year-old resident of Hamilton, nine years ago. After scraping by on low-paying jobs and welfare, she cashed in a winning ticket for more than $10 million. But after travel and cars and other purchases ate up her fortune, she’s right back to where she started - becoming just one of many big lottery winners who went from rags to riches and back again.

[More: 4 reasons why you spend so much (and what you can do about it)]

How could this happen? How could someone used to living on so much less spend all that money?

A million-dollar lesson

Think back to that big bowl of candy. The bigger the bowl, the more you eat. The same is true for money. The bigger the sum, the more indiscriminately you’re likely to spend it, believing that if the pile is deep enough, you’ll never have to worry about hitting the bottom. It’s the same fantasy for those who struggle financially and come up short every month.

Whether you have an extra $10,000 or $10 million, the lesson is the same: If you dive in indiscriminately, it won’t be long before you’re scraping the bottom of the bowl. And whether you’re rich or poor, that’s one lesson worth at least a million bucks.

GoldenGirlFinance.com is a free personal finance and education site for women.

Nothing contained herein is intended to provide personalized financial, legal or tax advice. Before implementing any financial strategy, you should obtain information and advice from your financial, legal and/or tax advisers who are fully aware of your individual circumstances.

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