I noticed a lot of coverage today about the $370M Mega Millions Lottery jackpot. I found some of the trivia in the coverage interesting, like:

The odds of picking the six correct numbers and taking home the mountain of cash are 1 in 175,711,536. That’s “175,” as in millions. Those odds are even worse than one of those carnival booths where you pitch a dime and try to get it to land on a piece of glass.

1 in 175,711,536. Astonishingly small. Of course, it’s $1 per ticket, and with a $370 Million jackpot, it seems like the expected value of a ticket would be higher than $1… assuming that you don’t end up splitting the pot with someone else.

Personally, I’ve never been a big fan of the lottery. I do have a little libertarian voice in my head that says, “Go ahead. If people want to gamble, it’s their money.” Of course, I have this other voice, call it my nagging sense of social justice that says, “This is just a regressive tax on people who are bad at math or have a low-level gambling addiction.”

I never play, which is why when I ask my wife,

“What would you do if we won the lottery?”

She tells me,

“You have to play to win, honey. You have to play to win.”

In any case, I’ve always been fascinated with the stories of lottery winners who blow many lifetimes worth of money in a matter of years. Similar to professional athletes who blow fortunes after they retire, I’ve always felt that these cases prove that no amount of money can substitute for being educated in personal finance, and being prudent with money.

Well, there is an inspirational story here of a lottery winner who actually handled his money well. Graceful Flavor, which I typically read for Apple-related news, had a nice write-up on this story. The original article actually breaks down what this winner spent his money on:

$45 million: Safe, low-risk investments such as municipal bonds $35 million: Aggressive investments like oil and gas and real estate $1.3 million: A family foundation $63,000: A trip to Tahiti with 17 friends $125,000: Mortgage retired on his 1,400-square-foot house $18,000: Student-loan repayment $65,000: New bicycles, including a $12,000 BMC road bike $14,500: A used black VW Jetta $12,000: Annual gift to each family member

Let’s just walk down the understated brilliance of how this man, Brad Duke, actually allocated his money after winning a $220 Million jackpot. You see, Brad spent time researching the stories of other lottery winners, and I think there are lessons here for all of us who may (hopefully) be faced with a small windfall someday.

1. Municipal Bonds. This is exactly right. Largely risk-free, this guarantees Brad a tax-fee investment that will provide regular income, indefinitely, and will likely match inflation over time. This provides a wonderful base of income for him, indefinitely.
2. Aggressive investments. This is likely his riskiest endeavor, but with a base level of income guaranteed, he has freedom here to be more aggressive, and try to scale his assets over time.
3. Family Foundation & Gifts. Nice clear breakout of what he’ll be giving to charity, and gifts to family members. Note the lack of family members “on the payroll” – a sure-fire track to the money problems.
4. Trip to Tahiti & Bicycles. You have to celebrate. $128K is not a large amount here, and it represents some fun with the winnings. Most personal finance experts agree that if you try to save every single dime, you can end up feeling deprived, and it can lead to impulsive behavior. This trip sounds like a great way to have fun, do something extravagant
5. Student Loan & Mortgage Paid Off. In the world of debt, student loans and mortgage are the best possible forms of leverage. Low interest, with tax advantages, and typically a large payoff on the investment. Still, once you have ample assets, reducing debt reduces risk. It’s that simple.
6. The Used Jetta. This is probably what impresses people the most. He sold his 2005 car, and bought another used car! This is a good sign of someone who isn’t frugal because they have to be, but because they just don’t like to waste money.

It’s hard to say what you might do with a windfall of $100,000 or $100,000,000. Oh, I guess it’s easy enough to guess, but I have a feeling that reality is always more complicated than idle dreams.

Living in Silicon Valley, it is not uncommon to have friends and family who come across fairly large windfalls. A company goes public, or is sold. A relative passes on an inheritance. The fact that so many people who have large windfalls in their lives end up losing the money in short order is a warning. Managing money is difficult, and the right habits and the right attitude towards it will likely benefit you at any asset level.

Of course, you do have to play to win.

I have so many things to post about today, I doubt I’ll get to them all.

However, I couldn’t let the day close without commenting on the big financial news, namely the fairly large drop in global stock markets today. The AP Wire has a nice summary of the financial metrics from the day:

It began Monday with a 9 percent slide in Chinese stocks, which came a day after investors sent Shanghai’s benchmark index to a record high close, setting the tone for U.S. trading Tuesday. The Dow began the day falling sharply, and the decline accelerated throughout the course of the session before stocks took a huge plunge in late afternoon as computer-driven sell programs kicked in, and also as a computer glitch caused a delay in the recording of a large number of trades.

The Dow fell 546.20, or 4.3 percent, to 12,086.06 before recovering some ground in the last hour of trading to close down 416.02, or 3.29 percent, at 12,216.24, leaving it in negative territory for the year. Because the worst of the plunge took place after 2:30 p.m., the New York Stock Exchange’s trading limits, designed to halt such precipitous moves, were not activated.

In the grand scheme of things, today’s move in the stock market was neither unusual nor extremely worrisome for a long term inventor with a well thought out asset allocation. However, people are not rational with money, and loss aversion is one of the best documented aspects of behavior finance. Most research available on the topic demonstrate repeatedly that people tend to value the loss of a dollar three times more than the gain of a dollar. It’s amazing, really. The joy you likely feel seeing your portfolio up $1000 is likely 1/3 the pain you feel when you see it drop $1000. That is not a recipe for rational decisions.

I’ll be writing my next article in my personal finance education series soon, most likely on the topic of asset allocation and long term investing. Days like today can be extremely stressful if you are in the stock market for the wrong reasons, with the wrong goals, or with the wrong expectations. However, days like today can be a blessing if they force you to really embrace what risk really means in terms of the day-to-day unpredictability of the stock market.

In the meantime, however, I’d like to share an article written today by Vanguard, the puts market volatility like today’s in perspective. Here are a few lines that I felt were extremely well put:

“There’s no doubt that a big drop in stocks can be tough on your nerves and your account balance,” said Gus Sauter, Vanguard’s chief investment officer. “But after a day like Tuesday, it’s more important than ever to maintain a long-term perspective…”

Tuesday’s decline put the stock market’s return so far in 2007 into negative territory. But over the past 12 months, the broad stock market has still produced a total return—price appreciation plus dividend income—exceeding 10%. That gain, coincidentally, is roughly the long-term average annual return for U.S. stocks….

“We’ve had a very nice rebound in stocks since the long bear market that began in early 2000 and stretched into 2002,” Mr. Sauter said. “So it’s not surprising to see a pullback…”

As investors digest the volatility of the market and the flood of commentary that always accompanies such events, it may be helpful to reflect that no one can say whether stocks will continue to decline or whether they’ll soon rebound. What is clear is that few, if any, investors have a demonstrated ability to consistently pick the right times to get in—or out—of the markets…

“The stock market never goes straight up,” Mr. Sauter said. “To be a successful investor over the long term, you need to understand this fact and you need to react rationally when the market doesn’t go your way.

“Successful investing is a rational, not an emotional, pursuit. If you’ve made conscious, deliberate decisions based on your personal financial goals, time horizon, and your tolerance for risk, there’s no reason to change your plans.”

One of my favorite pieces of advice that I give about investing is that for most people, you know when you are doing it well because it will be boring. For people who do not make their living in the financial markets, it should take very little time to pick a well-balanced, diversified portfolio of assets, and then add money to it regularly. Rebalance once, maybe twice, a year, and you are done.