March 11, 2026 Smart Investing admin

Gambling, Risk-Seeking, and Lessons from Lottery Stocks

Stock market tickets and prices

While many essential costs have risen sharply over the past decades, one category of discretionary expenses has grown especially rapidly:

Since 1979:
• Inflation (CPI) is up ~3x
• Nominal wages are up ~4x
• Personal gambling expenditures? Up ~38x

Data source: St. Louis Federal Reserve – see disclosures for details.

This appetite for risk doesn’t stop at casinos or horse tracks. Studies suggest stock markets contain roughly 3–4x more gambling-type activity than traditional betting venues.1 Same instincts—just wrapped in ticker symbols. This effect has even drawn the ire of some of the world’s top investors, like Warren Buffett who said in his 2024 shareholder letter, “For whatever reasons, markets now exhibit far more casino-like behavior than they did when I was young.”

So, what’s a thoughtful investor to do?

Academic research helps explain how this risk-seeking behavior manifests in stock markets. It’s well documented in the literature that a subset of individual investors are systematically drawn to stocks with lottery-like features – typically highly volatile, small companies with the potential for extreme positive returns. These investors are effectively chasing skewness: they’re willing to accept lower average returns for a small chance at a huge payoff. Kumar, Page, and Spalt (2016) formalize this by constructing a “lottery stock index” and show that such stocks are disproportionately held and traded by investors with gambling preferences.2

As an example, consider an early-stage biotech firm dependent on a single Phase 3 trial, or other speculative companies where success or failure can hinge on a single event. If the trial succeeds, the company’s value can increase dramatically; if it fails, years of research may lead to little or no payoff. The upside can look enormous—but on average, these stocks significantly underperform the broader market. So, in aggregate, this preference for lottery-like payoffs correlates with future underperformance. The very characteristics retail investors find appealing—high upside potential and extreme outcomes—tend to come at the cost of long-term returns.3 

There’s no formal definition of a lottery stock (academics typically identify them by high positive skewness and idiosyncratic volatility). For practical purposes, we approximate lottery stocks using a few observable traits:

• Smaller size
• High valuations
• Low or negative profitability

Using Ken French data, we can group stocks by these characteristics and compare them to the market. A consistent pattern emerges: significant underperformance across regions and time periods.4

From 1990–2025:
$100 invested in the US stock market → $4,130
$100 invested in lottery stocks  â†’ $195

US stocks vs lottery stocks

Data source: Ken French Website and Dimensional Fund Advisors – see disclosures for details.

The underperformance of small-cap, high-valuation, low-profitability stocks is well documented over decades—it’s not solely due to increased gambling behavior, but the pattern reinforces the broader lesson. Diversification isn’t about owning everything indiscriminately. Sometimes the disciplined move is to avoid areas of the market where expected returns are low—whether due to fundamental reasons or investor behavior. Our focus here is on lottery-like stocks, but increased risk-seeking behavior could theoretically affect the broader market (however, for large, liquid companies, any effects are likely much smaller).

Others can chase the lottery—in the markets or the casino. I prefer to invest where the probabilities are on my side. Be the house.

Disclosures:

This piece is for informational purposes only and not meant to constitute personal financial advice.

1. Kumar, A., Nguyen, H., & Putnins, T. J. (2021). Only gamble in town: Stock market gambling around the world and market efficiency. SSRN Electronic Journal. https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3686393

2. Kumar, A., Page, J. K., & Spalt, O. G. (2016). Gambling and comovement. Journal of Financial and Quantitative Analysis, 51(1), 85–111. https://doi.org/10.1017/S0022109016000089

3. Lin, T.C., & Liu, X. (2017). Skewness, individual investor preference, and the crosssection of stock returns. Review of Finance, 22(5), 1841–1876. https://doi.org/10.1093/rof/rfx036

4. https://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html. Copyright 2026 Eugene F. Fama and Kenneth R. French. “Lottery stocks” proxied by small-cap, low book-to-market, low profitability portfolio in Ken French data library.

Additional Reference. Eraker, B., & Ready, M. (2015). Do investors overpay for stocks with lotterylike payoffs? An examination of the returns of OTC stocks. Journal of Financial Economics, 115(3), 486–504. https://doi.org/10.1016/j.jfineco.2014.11.002

Chart Sources and Notes

  • Median nominal wages (second quartile) used as a proxy for typical earnings growth.
  • Housing: Average Sales Price of Houses Sold in US
  • Medical care: Medical Care in U.S. City Average
  • Child Care & Tuition: Tuition, Other School Fees, and Childcare in U.S. City Average
  • Gambling Expenditures: Personal consumption expenditures: Services: Gambling

FRED links:

Stock Market Data

  • US Stock Market Returns: Fama/French Total US Market Research Index, Jan 1990–Dec 2025.
  • Data sourced from Dimensional Fund Advisors / Ken French Website.
  • Indexes are not investible and are used for illustrative purposes only. Past performance is not a guarantee of future results.