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Wealth is math.
That's bad news for math phobics, but it's great news for the rest of us because it means there are rules and science behind how wealth building works. It isn't random luck.
In Episode 19 of the Financial Mentor podcast we'll explore the most essential math principle to wealth building – the expected value formula.
This essential principle eludes most people because we inherently think in terms of probabilities – the likelihood of something occurring. It could be an investment going up or a business going bust. Either way, you most likely think in terms of the probability of the event occurring, and that is unfortunate.
Why? Because wealth is built according to expectancy – which is probability times payoff.
It's an entirely different way of thinking that produces surprising results. Discover how expectancy will literally determine the financial outcome of your life, and how you can use this uncommon knowledge to make smarter, more profitable investment decisions.
In this episode you will discover:
- How a career as a professional poker player shaped Billy's view on traditional investing.
- The difference between gambling and investing.
- Why variance is a dangerously misleading measure of risk that can cost you a fortune.
- The concept of “edge” in investing or “competitive advantage” in business.
- How increasing sample size can lower risk, but only if you have positive expectancy.
- The essential difference between asset wealth and cash flow wealth.
- Why EV, or the expected value formula, permeates all forms of wealth building – paper assets, business, and real estate.
- How to use the expected value formula for every business and financial decision you'll make.
- The many dimensions to risk management revealed by a deep understanding of expectancy.
- How to make more by risking less.
- How diversification, when done incorrectly, can become di-worse-ification.
- How the pursuit of safety can put you at even greater risk.
- Why all expectancies are not created equal, and how that spells opportunity for you.
- The dangerous illusion of results, and why expectancy is actually more important.
- How recency bias causes you to make losing investments.
- The two essential skills you must develop to invest with greater profit and reliability.
- How to use risk management skills to raise your expectancy.
- The right (and wrong) time to avoid analysis-paralysis in the due diligence process and just pull the trigger.
- How to test any investment using the “cocktail napkin test”.
- How missing a positive EV investment is mathematically equivalent to negative EV, and avoiding negative EV is mathematically equivalent to positive EV.
- Why insurance makes good business sense, even when it has a negative expected value.
- The right and wrong way to use insurance to manage negative expectancy risk.
- and much more….
Resources and Links Mentioned in this Session Include:
- Billy's web site is ForeverJobless.com
- Billy's poker web site is BlueFirePoker.com
- My financial coaching information
- Billy's EV:Millionair's Math post.
- The 7 Steps To 7 Figures group coaching curriculum.
- A collection of articles on this site about risk management
- The key difference between gambling and investing.
- Investment due diligence articles on this site.
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The One Decision That Can Make Or Break Your Financial Future
There are only four paths you can choose from.
Click below to find out which path is best for you, and why.
This post explains one of the ideas that defines the Berkshire Hathaway methodology in an incredibly accessible way. To the other Munger/Buffett fans out there who might eventually come across this information, I suspect understanding this concept reveals the thought process behind a lot of the business decisions he makes. This is probably why he can make choices so fast, and he speaks so strongly against derivatives. It’s probably also why he uses the patsy analogy.
This excerpt of a speech from Charlie Munger’s almanac on worldy wisdom refers to the concept in this podcast as critical in life and the last line shows how critical.
…… And the great useful model, after compound interest, is the elementary math of permutations and combinations. And that was taught in my day in the sophomore year in high school. I suppose by now in great private schools, it’s probably down to the eighth grade or so.
It’s very simple algebra. It was all worked out in the course of about one year between Pascal and Fermat. They worked it out casually in a series of letters.
It’s not that hard to learn. What is hard is to get so you use it routinely almost everyday of your life. The Fermat/Pascal system is dramatically consonant with the way that the world works. And it’s fundamental truth. So you simply have to have the technique.
Many educational institutions—although not nearly enough—have realized this. At Harvard Business School, the great quantitative thing that bonds the first-year class together is what they call decision tree theory. All they do is take high school algebra and apply it to real life problems. And the students love it. They’re amazed to find that high school algebra works in life….
By and large, as it works out, people can’t naturally and automatically do this. If you understand elementary psychology, the reason they can’t is really quite simple: The basic neural network of the brain is there through broad genetic and cultural evolution. And it’s not Fermat/Pascal. It uses a very crude, shortcut-type of approximation. It’s got elements of Fermat/Pascal in it. However, it’s not good.
So you have to learn in a very usable way this very elementary math and use it routinely in life—just the way if you want to become a golfer, you can’t use the natural swing that broad evolution gave you. You have to learn—to have a certain grip and swing in a different way to realize your full potential as a golfer.
If you don’t get this elementary, but mildly unnatural, mathematics of elementary probability into your repertoire, then you go through a long life like a onelegged man in an asskicking contest. You’re giving a huge advantage to everybody else.
I must say….
The information on this site is just consistently incredible. This website has a way of pre-identifying problems that come into your way in the wealth building arena, and showing you a path to solving them using concepts and techniques that you didn’t even know existed.
Hey Todd,
I just reviewed/recommended your podcast (and some others) as a great way to increase your personal finance knowledge. Check it out if you get a minute.
Best,
Chris
ChrisEE Thanks for your support by including my podcast in your “recommended” list. Much appreciated!