Our current national mania for the Mega Millions jackpot, projected to hit $1.55 billion by Tuesday's drawing, would almost certainly excite the scorn of Ambrose Bierce.
A largely forgotten American writer, Bierce was the guy who came up with that oft-quoted line about the lottery being a tax on people who are bad at math. His whole brand was acerbic wit, and I guess he was considered to be pretty hilarious by the standards of 1911, but on this particular subject I think Bierce was a jerk.
The vast majority of people plonking down two bucks for a Mega Millions lottery ticket are not statisticians, and yet I bet they know intuitively that they have no realistic chance of winning. Sure, you could tell them that the odds of guessing all six numbers correctly – 1 in 302.6 million – are effectively the same as zero. Grab folks by the hair and explain that they are far more likely to die in a dog attack (odds: 1 in 58,843), and they're more apt to weigh the possibility of Fluffy murdering them in their sleep than consider their chances of not hitting the jackpot.
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Remember the tagline "a dollar and a dream?" That's what it's all about – for most people anyway. Sure, there are folks who dump serious money into lottery tickets. This is both bad and sad. But most of us just want to indulge in a little reverie. Cognitively I'm quite certain that I'm not going to win the Mega Millions. And yet I also know that someone somewhere eventually will. And until that person hits the number, why not irrationally fantasize about it being me?
Investing my millions
The true purpose of this post is to illustrate how even a teeny, tiny bit of interest earned on a big enough chunk of money will generate tremendous income. And that's especially the case once we factor in the miracle of compounding. There's an old finance joke about compounding that goes like this:
Question: How do you make a great fortune on Wall Street?
Answer: Start with a small one.
Whomever wins the Mega Millions jackpot will find themselves holding a lot more than a small fortune.
As noted above, the Mega Millions jackpot is projected to top $1.55 billion by Tuesday's drawing. The lump sum payout, should the winner elect to go that route, will be something like $757.2 million. Federal taxes on lottery winnings will reduce that sum substantially. And unless the winner lives in one of the eight states that don't tax lottery winnings, state taxes will take a big bite too.
Nevertheless, the Mega Millions winner will still walk away with a mind-blowing amount of cash. Since this is just for fun, let's keep things simple and say that the Mega Millions winner takes home an even $500 million.
Let's pause on that number for a moment. A half-a-billion dollars, after taxes, in cash, is a stunning amount of money. That puts you not just in the top 1%, it makes you a member of the fraction-of-the-1%. In the nomenclature of the wealth management industry, you are now known as an ultra-high-net-worth (UHNW) individual. You are a whale.
So how do you invest these many hundreds of millions of dollars?
Here's my serious answer: you need to hire professionals. You must avail yourself of comprehensive wealth management services that can handle everything from planning to accounting to taxes to legal matters. Private bankers, sundry types of wealth managers and registered investment advisors (RIAs) catering to UHNW clients, or family offices (which are kind of like private hedge funds offering one-stop shopping for the super rich) will do – and they will all fight for your business.
It's a nice problem to have, for sure, but it's still a problem. And let's never forget the iron rule: more money, more problems.
Putting my Mega Millions in Treasurys
Since I want more money but I don't want more problems, I have daydreamed about the laziest and easiest way to invest such an obscene amount of money. My conclusion: Treasury securities.
Treasury securities are just about the safest thing you can do with your cash. The risk of default is vanishingly small, a recent downgrade of the United States' credit rating, notwithstanding. The federal government is going to pay back your loan. And if you buy and hold your Treasury bills, notes and bonds to maturity, you needn't really worry about interest rate risk. True, there's inflation risk, but then you can manage that by building a bond ladder. A bond ladder also helps with the aforementioned interest rate risk.
Oh, and in another plus, interest income earned on Treasury securities is exempt from all state and local income taxes.
The inverted yield curve means that short-term government debt yields a lot more than long-term debt these days, which is weird and wrong and won't be the case forever. As of August 4, however, 1-month Treasury bills were yielding 5.54%. You won't get that exact yield on the secondary market or at auction (the Treasury allows folks to buy up to $10 million in Treasury securities if they make a non-competitive bid), but let's do the arithmetic for the lulz.
At 5.54%, the income from lending the federal government $500 million for one month comes to $2.3 million, or $27.7 million annualized. That's not a bad payday, especially when it's your cash that's doing all the heavy lifting. You can see why Warren Buffett, chairman and CEO of Berkshire Hathaway (BRK.B), likes to keep so much of his holding company's cash circulating in short-term Treasurys.
Further down the yield curve, the benchmark 10-year Treasury note yielded 4.05% as of August 4. At that rate, a $500 million investment would pay $10,125,000 every six months for the next decade – at which point the government would return the half-billion dollars you so generously leant it way back when.
The point here is that even a measly 3% coupon on "only" $100 million worth of bonds equals $3 million in income a year. Reinvest what you don't spend and watch your fortune compound exponentially.
Whatever I ultimately do with my Mega Millions millions, I will be focused on the return of my principal, not the return on my principal. When you have $500 million to play with, even low returns generate huge sums. Less risk equals less reward, but if you've already hit the jackpot, how much more reward do you need?
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