Adventures in Personal Finance, Part 3: The Poor Single Mother

We've already seen that the middle classes can have more financial horse-sense than the rich. Where do the lower classes fit in? It turns out that they, too, can be eminently sensible.

Exhibit C: Kristina Schneider, a single mother who works as a cashier at a BP station in North Canton, Ohio. She got lucky last week: she found a ten-dollar bill lying on the floor. Then she decided to push her luck by using her newfound cash to splurge on a Magnificent Millions lottery ticket. And she won.

At that point, after understandably throwing up in the bathroom, she elected to take 20 yearly payments of $50,000, rather than a lump sum of (I think, it's unclear from the website) $500,000. She spoke to the AP:

"If I'd have taken a lump sum, I'd be broke again within five years," she said.

Now a financial sophisticate can find all manner of things to scoff at, here, starting with the fact that Ms Schneider bought a lottery ticket in the first place. In fact, however, her actions can be justified economically, if you look at lottery tickets as a way of buying a "transforming fantasy".

Given that the annual payments are worth less than the lump sum, on a net present value basis, it would surely make more sense for her to take the lump sum and put it into some kind of trust where she can only spend the income. As for going broke, if she has a guaranteed income of $50,000 a year for 20 years, she can end up borrowing against that income and going broke anyway.

But Ms Schneider lives in the real world, where people don't set up trusts they can't touch, and where they don't borrow against guaranteed future income. In her world, people have income and expenses, and when the latter exceed the former, they have debts. In Ms Schneider's case, her debts amount to nine maxed-out credit cards, plus $8,500 in student loans. Chances are, she'll have relatively little money from her first annual check left over once she's paid taxes and debts.

And that's the whole point. If she was given more, she would spend more. As it is, she's getting a modest windfall ($34,500 after taxes), which can transform her personal finances without giving her a sense of financial invulnerability. And that's the best situation she can be in, long-term.

(Via Joseph Weisenthal)