Can The Lottery Make People Save More?
from the tax-on-the-poor dept
The lottery has often been described as a “tax on those who don’t understand probability.” However, it seems some enterprising folks are trying to use that basic fact to help people who have trouble saving money (who often overlap with the folks who don’t understand probability) to save more. Apparently some credit unions in Michigan are experimenting with a lottery feature as a part of a savings account:
Psychologists have long known that people tend to overestimate the odds of rare events. Applying that behavioral insight, finance professor Peter Tufano of Harvard Business School has devised a clever program called “Save to Win.” Launched earlier this year for members of eight credit unions in Michigan, it is a cross between a certificate of deposit and a raffle ticket. Members who put $25 or more into a Save to Win one-year CD are entered into a monthly “savings raffle” for prizes up to $400, plus one annual drawing for a $100,000 jackpot.
Apparently, this program has attracted $3.1 million in new deposits, many (the article claims) from people who have never been able to save much money. In many ways it is like buying a lottery ticket, except that you don’t lose the money paid for the ticket. The credit unions make this work by paying out a slightly lower interest rate on the CD in question, but the net effect works out to benefit everyone. Many who put their money into such an account would never have put their money into a higher rate CD in the first place. In some ways, it’s a neat example of efficient price discrimination that expands an overall market.
Filed Under: credit unions, lottery, michigan, probability, savings
Comments on “Can The Lottery Make People Save More?”
so in other words
its a customer loyalty scheme with a name that sounds like you’re gambling, and thus more “fun”?
This is genius
Whomever came up with this should get a Wall Street-sized bonus.
Re: This is genius
That’s a great idea! The guy who came up with the idea can thus enjoy a movie at the cinema (if he doesn’t buy popcorn)!
Re: This is genius
Wait… do you mean the Wall-Street bonus where he’s put up against the wall and shot?
Or do you mean the Wall-Street bonu$, ob$cene gob$ of ca$h?
In the UK we’ve had premium bonds – basically the same idea – for over 50 years. In this case the only return is the prizes – but if you buy a reasonable amount then you are practically guaranteed a steady stream of small prizes so it does work as an investment too
Great spin on the story
It’s interesting to note how the credit union has managed to put a lovely positive spin on this story, by having it look like it helps people save money. The credit union/banks are interested in having liquidity available at the lowest possible price, and by offering a low chance of some lottery win, they con people into giving them that liquidity at a lower than market price. Excellent scheme 😉
Anyway, as mentioned by Richard, premium bonds have existed in Europe for many years, so it’s hardly up-to-standards-Harvard material from the finance professor to come up with this plan. In Denmark, the state has stopped issuing premium bonds, but the private banks have taken over by offering a “Millionærkonto” (millionaires account), on which you get a lottery ticket for each 100 DKK, and a lowered interest rate on your savings.
Re: Great spin on the story
correction: the millionaires accounts in Denmark apparently have zero interest rate – the one million DKK drawing is once a month, and I suspect the FSA review the drawings and number of winners.
Re: Great spin on the story
“I’s hardly up-to-standards-Harvard material?” No, it’s not hemorrhaging money, so I suppose it’s not Harvard-caliber.
Re: Great spin on the story
” by having it look like it helps people save money”
It’s interesting to note how you’re putting a negative spin on it. Mike pointed out “many (the article claims) from people who have never been able to save much money”. Therefore it is helping them by having them put money in a bank. If the bank gets more for it, the banks will continue doing it. It helps everyone involved. There isn’t anything stopping the people reinvesting in normal plans later.
Bottom line: even savings with zero interest are a better investment than giving your money away to the state lottery.
Re: Re: Great spin on the story
It’s sad that you need to con people with such a shifty-sounding scheme to get them to save, but I’ve gotta agree with Scarr that if this encourages -ANY- savings, that’s far better than people squandering their money on state lotteries.
Legality of 100k Raffle
Pretty sure the bank is walking a thin line on this one. If it’s a sweepstakes there are rather strict legal requirements for a prize this size. If it’s actually a lottery, I’m pretty sure it’s illegal.
To me, looks more like a lottery, $25 per ticket. Guessing there is a rule on how many entries. Basically if you’re investing multiples of $25, should just put into multiple save-to-win CDs.
Re: Legality of 100k Raffle
Pretty sure the bank is walking a thin line on this one.
You’re forgetting who owns the gov’t.
Michigan law grants licenses to private entities to operate raffles (under certain restrictions). I’d imagine the credit union has filed the appropriate paperwork.
This was all done assuming no additional contributions per month and the real-world would absolutely be different, this is just a theoretical look. It also assumed the $3.1M occurs all at once at the beginning of the raffle period. If you notice an error, by all means point it out. I’d like to learn where I went wrong as finance is not my forte.
Far as I can tell, the raffles give out (12 x $4,000) + (1 x $100,000) = $148,000. It would take roughly 4.5% “skimmed” (yearly, compounded monthly) from $3.1 million by these credit unions in order to fund the raffles.
The link provided in the article states:
This unusual CD is federally guaranteed by the National Credit Union Administration and pays between 1% and 1.5% annual interest.
That would mean the typical savings account is between 5.5% to 6% (if the credit unions have to skim 4.5% to enable this program). This seems rather high…
At $3.1 million, there are at most 124,000 unique participants. This raffle system increases average yearly wealth of those people by ($148,000 + $3.1M @ 1.5%) / 124,000 = $25.37 per person.
A typical savings account would increase the average yearly wealth of those people by ($3.1M @ 5.5%) / 124,000 = $26.41 per person. A total difference of $128,984.
I wasn’t sure going into this what the difference would be, it still favors people just saving the ol’ fashioned way, but the difference doesn’t seem to be too excessive to discount the raffle approach. And, at least this way, it is giving people [false] incentive to save money which they normally would have just spent and would not have gone towards increasing average yearly wealth anyways. And, of course, the one person that wins the $100,000 will swear by this method.
Re: Re:
Ah…yes…however, there will be a critical point (am too tired to do the math right now) Where a single person opening up multiple $25 accounts will actually increase his chances of winning said prizes to the point where the Expected Value of his winnings plus his lowered interest rate will actually result in an increase in his yearly earnings…
Re: Re:
Re: Re:
Small mistake on my part. Used $4,000 instead of $400. The article mentioned prizes “up to $400”, which may mean multiple prizes totaling more than $400. Either way, re-calculating with $400 drops the average yearly wealth by $0.35, or $25.02, per person. Increasing the difference total between the two methods by $172,384.
Again, it doesn’t appear to be the largest difference and, if the alternative for this money is being spent (as opposed to being saved normally), this seems like an overall positive (As long as people don’t withdraw too much and the credit unions are earning enough interest to pay off their raffles. Unless, they are earning money some other way for this?)
Quite Common In Some Regions
Oddly enough, this is how many Islamic banks work. Some Muslims interpret the ban on “usury” in the Quran as meaning that interest payments on loans and deposits are not allowed. But there doesn’t seem to be a similar prohibition against gambling, so banks giving out lottery prizes to depositors is acceptable.
What does CD mean? certificate of deposit?
Certainly a good way to promote saving without explicitly promoting saving.
Premium Bonds
Premium bonds in the U.K. and elsewhere are designed to provide a set return through prizes. The bonds are in such small denominations that investing a few hundred pounds used to provide about 3% return (back in 2003 – not sure what it is now) to the average investor through the small prizes and still provide a chance at the big prizes. Limits are placed on how much an individual can invest (used to be 30,000 pounds). Financial advisors in the U.K. generally recommend premium bonds for most portfolios.
We’ve had them in Ireland for decades too, they’re called Prize Bonds