Have you ever wondered why so many people play the lottery when the odds of winning are so small? Recently, I decided to do a little research to see what the odds actually are. I naturally thought of Mega Millions, which has had some of the largest payouts in lottery history. To win the big jackpot, you
have to guess the correct number on each of 6 randomly-drawn balls – 5 regular balls and the Mega Ball.
A recent Mega Millions jackpot was $17,400,000 (small by historical comparison). The odds of winning were 302,575,350 to 1. However, the odds alone do not tell us if it’s a good deal. To figure that out, we need to know the expected value. Expected value is the average gain or loss of an event if we repeat the procedure many times. If an opportunity has a positive (negative) expected value on average you can expect to win (lose) money. In the case of the lottery, the expected value of buying one lottery ticket is the cost of the ticket, or $2.00, plus the probability of winning the prize, or $17,400,000 times 1 divided by the odds. On average, one can expect to lose $1.94 on a $2.00 lottery ticket. (Of course, most players will lose the entire $2.00.) This doesn’t seem like a good deal. Yet people tie up grocery and convenience store lines throwing their hard-earned money at the possibility – however small – of a life-altering outcome.
Why play the lottery when it is such a bad deal?
Lottery players tend to focus their attention on the jackpot, not the expected value (or even the odds). But why? One explanation is that they are exhibiting availability bias, a cognitive bias that occurs when people judge the likelihood of an event – in this case a jackpot win – by the ease with which examples and instances come to mind. Case in point: the internet typically buzzes about lottery jackpots. Newspapers across the country publish articles and catchy bylines about it. When someone wins, the media brims with excitement, photographing the winner(s) standing next to an over-sized bank check. It is no surprise that with all this hype, people would flock to ticket locations before the next drawing. What would happen if there were an equal number of prominent news articles mentioning the millions who played and lost? Imagine a newspaper headline, “250 Million Americans Lose the Lottery”. These stories don’t capture the reader’s attention. When it comes to the lottery, people want to see the success stories, not the failures. Because the success stories are more available to them than stories about failures, the successes stick in their minds and influence them to purchase lottery tickets.
Availability bias is the inclination for people to make decisions or conclusions based on information and events that are more recent, that were observed personally, or are more memorable. If we can recall something easily, or experience it personally, we are more likely to attach importance to it. When subject to this bias, we do not check the reliability or the contextual nature of information we rely on, nor do we try to search for patterns beyond a time horizon that our memory can recall. Our minds choose the path of least effort. Looking beyond readily available data takes more cognitive effort so we tend to avoid it.
Factors influencing availability bias
We can become vulnerable to availability bias in a variety of ways. Recency of the data under consideration is one. It’s easier to recall more recent events. A recent home invasion reported on the local news is more likely to get someone to install a security alarm than the long-established statistic of low violent crime rates in their city.
The frequency with which the information is reported also influences our ability to recall it. If we see a news item often, we’ll remember it and attach more significance to it. We see this occurring with political candidates, where they try to defame their political opponent by bombarding us with ads.
The more ubiquitous the information, the more it can influence our beliefs or decisions. The lottery advertisements are a good example of this. Next time the Mega Millions jackpot reaches $1 billion, try to find one news source that isn’t reporting on it.
Personal experience plays a major role in availability bias, and the more intense that experience, the more likely it is to influence us. The next time you experience severe turbulence on an airplane, you might think twice before getting on another one, even though air travel is one of the safest forms of travel.
Investors are particularly vulnerable to availability bias
Availability bias plays a huge part in personal finance, especially investing. During bull markets, many investors abandon a disciplined long-term approach to investing. They overweight their portfolios with unproven tech stocks or a “rising star” mutual fund based on sensationalistic magazine articles. This is the information most readily available to them, so they feel they must act on it.
Availability bias also works in the opposite direction. During bear markets, when there are doom and gloom news articles lamenting a sputtering economy and a world in turmoil, many investors will ditch their analytical approach and unload their losses. They are convinced the world is going to hell in a handbasket, and they want out.
In fact, mutual fund companies change their marketing strategies, depending on the direction of the stock market. They advertise aggressive strategies during bull markets and the slow and steady approach during bear markets. Investors consume this information because it is what’s most readily available, and they act on it.
Investors who act only on information that is easily available take a reactive approach to investing, buying high when sentiment is positive and selling low when the talk turns to recessions and budget deficits. Over-confidence during a market run-up can turn to fear and panic during a downslide if we consume only the information that is readily available to us in the moment.
How to counteract availability bias in your financial life
With the plethora of media these days, it can be difficult to distinguish the wheat from the chaff in investing news. For every pundit predicting a rise in interest rates or inflation, there is another predicting a decline in rates or deflation. Which view you believe might depend on which one you hear (or read) the most.
Because we are all vulnerable to availability bias, it is useful to establish a thoughtful investing strategy ahead of time based on your overall financial plan, and that recognizes the risks of availability bias. Your financial advisor can provide relevant information that may not be readily available to you to help you make an informed decision. Then stick with your strategy through up and down markets. One element of the strategy would be to not listen closely to the financial news. If you find yourself tempted to make a change based on information you read or hear, recall your strategy, and remember you chose it precisely to counteract the bias.
Interested in behavioral finance? Read on.