The Drive of the Lottery

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The Drive of the Lottery

The lottery is based on the most powerful way to motivate people and change their behavior: a variable reward in response to a specific behavior. This strategy produces more of the behavior than a consistent reward and more than a schedule of rewards based on an interval of time.

Electronic game designers use the variable ratio method of rewarding users to encourage them to keep playing. Accomplishing a certain goal of the game produces a random number of game rewards. If you defeat a villain, a variable number of desirables are dropped. On rare occasions you receive a jackpot reward that motivates you to search for another one. This surprise windfall offers more of an incentive than if you consistently received large prizes.

We are wired to believe that if we did not receive a jackpot yet, the likelihood of one coming up soon has increased. We fear that if we stop, we might miss that big payout. This cycle of false assumptions compels us to keep going in hopes our luck will change.

The variable ratio method of payment offers a changing payment in response to our demonstration of the desired behavior. In the case of electronic games, the desired behavior may be playing the game, but in the case of work, it might be answering customer service calls. Many governments make this payment schedule illegal with regard to wages because of its addictive nature.

Thus most employers use a different payment schedule to reinforce working behavior. The most common one, fixed interval, is also the worst way to motivate people. A fixed interval pays out rewards based upon time passing. Your behavior has nothing to do with your receipt of a reward. For example, you go to work for a week and you receive a week’s wage regardless of your productivity. Hourly employment is just a shorter version of this. Your bank works the same way, paying you 1% interest simply for time passing. These payouts do not inspire any specific behavior other than showing up to work and waiting.

Variable ratio pay, in contrast, would mean that for every unit of work done, a worker would receive some random lottery amount of pay. This type of pay is so highly motivating that it is illegal, for fear that employees would overwork to acquire bigger payouts.

It also illegal for banks to pay interest this way. But recently more states are allowing credit unions to use this technique to boost deposits with what they call prize-linked savings accounts. These accounts, which are popular in several other countries, encourage bank or credit union customers to save money by variable ratio rewards.

For example, for every $25 invested in a 12-month certificate of deposit, the customer is given a lottery ticket up to a maximum of 10 tickets per month, or $250 saved. Local branches might award $50 prizes, and a grand prize winner of $25,000 might be chosen from the entire state pool.

These promotions could reduce interest paid but would not jeopardize the savings themselves. In the worst case scenario, participants would save a pile of money and receive a slightly lower interest rate. And they would still build savings or even just a $2,000 emergency fund.

Over half of Americans say they could not come up with $2,000 in 30 days if they had to. However, the average household spends about $540 annually on lotteries with poor households spending a higher than average percentage of their budget. These statistics include the 47% who don’t pay any federal income tax and the 20% of American households that receive food stamps.

But imagine if saving money in the bank was like the lottery. Studies suggest that prize-linked savings accounts boost savings by about 12%, reducing both current consumption and purchases of state-sponsored lottery tickets in the process.

The idea of helping the poor save money has a long history. In the 1700s, miners in Scotland would have a part of their pay set aside so they could not spend it all on a night of payday partying. Such innovations like a penny savings bank for the working class (rather than an investment bank for the wealthy) helped contribute to the Scottish reputation of thrift.

People living below their means enjoy financial peace of mind. They do not need to frequent payday loan shops. They have an economic margin. They are prepared for the proverbial rainy day. They grow financially independent. They can retire with confidence. And an increase in savings gives people capital to invest in business ventures. This increases national income (gross domestic product) and produces greater employment as well as a larger tax base. Increased savings makes life better.

Lotteries are normally a terrible idea because they motivate the wrong kind of behavior. A lottery merely encourages you to hand your hard-earned cash over to the lottery sponsor.

In contrast, a prize-linked savings account would encourage you to hold on to your money. Alas, states have little incentive to legalize these helpful accounts because the direct competition of prize-linked savings accounts is state-run lotteries. But a few states have allowed credit unions to experiment with this way to promote savings.

The government could learn a lesson from their successful experiments and provide lottery-like prizes for earning or saving income in the lower tax brackets. Rather than paying people more money via welfare for the lesser income they report on their taxes, the government could provide a chance for a small cash prize for every $25 of additional reported income. This would incentivize building wealth, which brings with it a host of good things.

Variable ratio reward schedules are powerful tools. It is a shame that currently their primary use is to motivate voluntary taxation among our nation’s poor.

Photo used here under Flickr Creative Commons.

Follow David John Marotta:

President, CFP®, AIF®, AAMS®

David John Marotta is the Founder and President of Marotta Wealth Management. He played for the State Department chess team at age 11, graduated from Stanford, taught Computer and Information Science, and still loves math and strategy games. In addition to his financial writing, David is a co-author of The Haunting of Bob Cratchit.

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Megan Russell has worked with Marotta Wealth Management most of her life. She loves to find ways to make the complexities of financial planning accessible to everyone. She is the author of over 800 financial articles and is known for her expertise on tax planning.