What would you do with a dream lottery win?
Written by Adon Beddoes on April 17, 2018.
I was fascinated to read about a teenage lottery winner in Canada earlier this year. Charlie Lagarde celebrated turning 18 by buying a scratch card for the first time ever. It turned out to be a case of first time lucky as she won an enviable prize: the choice of a lump sum of $1m Canadian dollars or $1,000 per week for the rest of her life. Ms Lagarde opted for the weekly payments, but what would you do?
It’s an interesting dilemma so I thought I’d look at the two choices and the factors that the lucky winner should have taken into account when making up her mind.
If we use simple maths and base the choice merely on the amount received, the weekly payments come out on top as long as she doesn’t die in the next nineteen years.
The 18 year old only needs to reach the age of 37 to equal the lump sum payment of $1m and with average life expectancy for a Canadian woman at 84, the odds are in her favour. And if she does reach the grand old average age of 84 she will have received over C$3m in payments. Of course, for someone older, the decision based on these simple calculations may not be so clear cut.
At 18 many of us might be tempted to blow a lump sum and have little to show for it so I’d say this is another reason why Ms Lagarde is wise to opt for the weekly amounts. I might advise a different choice if she had large debts, such as a six-figure mortgage to pay off. In that situation, the savings on interest payments by zeroing the debt might make the lump sum more interesting.
Let’s not forget though that the calculations above don’t take into account the potential to earn interest or make a return on investment. How might that affect the decision? How does investing the lump sum compare to investing weekly payments? I ran some figures through a compound interest calculator.
If Charlie takes the $1m and invests it without spending anything, earning 5% interest (an achievable but by no means guaranteed figure), after 30 years she will have $4.3m. If she does the same with the weekly payments, which total $52,000 per year, she will only accumulate $3.7m over the same 30 year period. The power of compounding favours the lump sum option throughout her life, even if she lives to 84 and saves everything for the full 66 years.
And then there is the beast that is inflation to consider. As the cost of living rises over the years, the $1,000 weekly payment will buy Charlie less and less. According to the inflation calculator on the Bank of Canada website, a basket of goods costing $1,000 in 1978 would now cost $3,742.98 showing just how much inflation can diminish purchasing power. It is impossible to predict inflation rates in the future but if we see a similar trajectory over the next 40 years, $1,000 could be worth less than $250 by the time Charlie turns 60. If a return of 5% can be achieved, then perhaps the lump sum is the better option?
This may seem like pie-in-the-sky to you, let’s face it, most of us are not lottery winners, but in fact the same factors affecting Charlie’s decision come into play when we look at general financial planning. We all need to consider the trade-off of saving versus spending as we navigate our path through life and, if we are wise, build wealth to see us through retirement. When we reach retirement age, there are choices to be made over whether to drawdown lump sum payments from our savings, purchase an annuity or live off income from investments.
If there is one moral to draw from the the story, it is that professional advice is key to all financial decision-making. I hope Charlie Lagarde took the advice of a professional before making her choice and I urge you to do the same when it comes to your own financial planning. If you would like help working out what to do with your savings and how to prepare for retirement, why not get in touch? You can contact me at email@example.com for a free consultation.