Dear Powerball Winner: Ignore the Upshot and Take the Lump Sum

The Upshot’s advice to the Powerball winner is to forgo the lump sum and take the annuity. The lump sum payout is $930 million before taxes, while the certain annuity pays you (or to your estate if you die) $22.6 million every year for the next 30 years. That is equivalent to holding an ultra-safe asset with an annualized investment return of 2.843%. That’s around the yield on a 30-year US government bond, so it’s not bad given the tax advantages. The latter is one reason Josh Barro of the Upshot offers in support of the annuity; the other being to protect yourself from yourself. Now, if you are confident that you can control your urge to spend it all away and you are not utterly obsessed with capital preservation, I will show how you can do much, much, much better.

After taxes, the lump sum comes to $561.7 million. Let’s say you spend $61.7 million immediately to buy a mansion and a yacht, leaving you half-a-billion to invest. With such a large investment pool, Thomas Piketty has shown that you can get much larger returns than holding the market portfolio. This is because you get access to sophisticated asset management techniques like leveraged beta strategies. In English, the $500m capital cushion effectively allows you to borrow billions to enhance your returns.

But let’s say you don’t care for actively managed portfolios. What if you invested the entire half-a-billion in the S&P 500? How much would it be worth after 30 years? I ran the simulation over the returns available for the S&P500 in 1928–2015 which furnishes a sample of 58 30-year periods. On average, half-a-billion would accumulate to $13 billion at the end of 30 years.


The histogram above shows the accumulated value at the end of 30 years. You would’ve been worst off if you had invested your money in 1928, right before the world fell into the abyss of the Great Depression. Even so, you would’ve been worth $5 billion in 1958! You would’ve been best off investing in 1969 or 1974, either of which would’ve ended you up at $23 billion. But neither of these scenarios is representative.

Perhaps the most representative is the median performance over the whole sample, which would place your net worth at $11 billion. This is what you would be worth in 2045 if you are luckier than the unluckiest half of the cohorts but unluckier than the luckiest half. Also, as the histogram shows, the distribution has a long tail. This means that you should not be very surprised to end up with a net worth considerably greater than $11 billion.

I did not take inflation into account because it’s an equally valid critique of the annuity: Indeed, more so because equity is likely to outperform fixed-income if we (are lucky enough to) get serious inflation over the next thirty years. Inflation was most serious in the 1970s. If we restrict attention to the subsample of the twenty 30-year periods that include the seventies (starting somewhere in 1950–1970 and ending thirty years later in 1980–2000), the median accumulated wealth comes to $10 billion.

To quote the US President, “it’s not even close.” The Upshot got it so wrong because they somehow managed to ignore the most potent force in the world — the power of compounding.

So, take my advice and welcome to the 0.01%. Don’t forget to invite the Policy Tensor to Davos!

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