Good Winning A $10 Million Lottery: Investment Strategy And Reflections Essay Example

In this writing I will detail the thought process around the investing and asset allocation of the $10 million lottery jackpot I won. The objective of my plan is simple: obtain the best long-term capital appreciation while preventing permanent loss of capital. I am aware that the market value of my holdings will fluctuate, but I want to avoid losing capital over the long-term – so that my $10 million jackpot can compound and grow. The sum won is large enough so that I could live on dividends alone, and still grow my capital. This plan will be divided into xxx parts. Firstly, I will talk about the choice of the payment plan (lump sum vs. monthly installments). Secondly, I will talk about asset allocation and strategic choices.
The first challenge with winning the lottery is deciding whether I should decide to obtain a lump sum or yearly payments. I decided to pick a lump sum, due to many different factors. Firstly, taxes bear no implications as the lump sum it tax-exempt. Second, receiving a lump sum allows me to invest with the proper asset allocation instantly, and enjoy the benefit of these investments directly. Choosing monthly payments could be interesting for people who have little discipline in managing their personal finances as it would avoid them from misspending their new-found wealth, however I do not believe that it is the case for me. By choosing a lump sum, I can therefore start investing the vast majority of my lottery winnings and let these winnings compound. There is therefore a huge opportunity cost to taking the installment payments, because the money you did not receive is not invested yet (Taylor 1). By investing $10 million at a 5% return – achievable with a reasonable asset allocation – one generates $500,000 earnings in the first year. If one receives 10 installments payments of $1 million, the foregone income in the first year is $450,000, because the $1 million invested only generates $50,000 at the same rate of return. Note that this opportunity cost represents the 1st year, but gets more obvious afterwards. In the second year, the lump sum strategy generates $525,000 assuming earnings are reinvested at 5%, while the lump sum strategy generates $102,500 – giving a foregone income of $422,500 for choosing the installments option. Finally, I believe choosing the lump sum strategy is a safer choice as investing allows to protect the purchasing power of my winnings against the eroding effects of inflation. If inflation was to return to the 2% level targeted by central banks worldwide, this would erode the value of the installments received in the future. Moreover, this value erosion would be more and more pronounced as years go by. To conclude, the reasons mentioned above make the lump sum option a sound choice in my case.
I will now discuss how the money will be allocated: my goal is to attain an optimal balance between need for current income and capital appreciation. I do not actually need much income to lead a happy life but I enjoy travelling, so given my personal preferences I will keep $100,000 in cash for the first year, which will cover my living expenses, liquidity needs and unforeseen expenses as well as a few trips if I decide to. I will totally invest the remaining $9.9 million, meaning that I will only cash out 1% of total sum received for the first year. This may seem very conservative, however I see no use in cashing out all the jackpot and living lavishly. The $9.9 million will be invested according to the following asset allocation strategy: 60% stocks, 25% REITs and 15% bonds. Firstly, I decide to be aggressive with the stock allocation because I am young and this gives me the opportunity to have a very long investment horizon. Stocks historically have been the highest-yielding investment, outperforming all other assets classes, but these returns come at the expense of high volatility. Being very long-term oriented it is not a drawback for my strategy. This stock allocation will be shared between US equities, European equities and Emerging market equities. US market equities will be underweight because they are now historically expensive if one looks at the PE of Shiller (also referred to as cyclically adjusted price-earnings ratio). The emerging markets and European equities will both be overweight: the emerging equities because of the promising growth lying ahead and the European equities because of their still attractive valuations and because of the recent quantitative easing launched by the ECB in the beginning of 2015. REIT are essentially market-listed real estate, and I choose this vehicle for two reasons. Firstly because it is much more liquid than traditional real estate and I want to keep flexibility in my asset allocation. Secondly because real estate is one of the assets classes adding the most value to a traditional stock/bonds asset mix (Bekkers, Doeswijk & Lam 1). Finally, bonds will be only 15% of the portfolio. The first factor explaining this choice is firstly that as mentioned previously, I have a very-long term horizon. Therefore I do not need to invest in a lot of bonds which have historically yielded lower than stocks as I can withstand volatility. I still include them however as it will provide reliable interest payments I can cash out for my expenses. The second reason is that bonds are now historically expensive due to the fact that interest rates are extremely low by historical standards. Were interest rates to go up, the value of fixed-income securities would instantly drop in value. It is not a risk for someone holding the bond to maturity, however it would prevent me from doing strategic reallocations of capital if needed.
A last point to mention is taxes. To increase my overall returns I choose on purpose a long-term strategy to avoid triggering taxation. While I can use dividends or interest on bonds for current income needs, I am cautious with rebalancing my portfolio to avoid triggering capital gains: it has once again a huge opportunity cost, as the money paid for taxes could have been reinvested and could have generated returns for the foreseeable future.

Works cited

Bekkers, Niels and Doeswijk, and Lam, Trevin W., Strategic Asset Allocation: Determining the Optimal Portfolio with Ten Asset Classes, October 2009. Available at SSRN: http://ssrn.com/abstract=1368689
Short, Dough. "Is the Stock Market Cheap?" Advisor Perspectives. 2 Mar. 2015. Web. 15 Mar. 2015. Available at: http://www.advisorperspectives.com/dshort/updates/PE-Ratios-and-Market-Valuation.php
Taylor, Don, PhD. "What Lottery Winners Should Do." What Lottery Winners Should Do. Bankrate, 30 July 2007. Web. 15 Mar. 2015. Available at: http://www.bankrate.com/brm/news/DrDon/20070730_lottery_payout_annuity_a1.asp