#56: Former professional Poker player Billy Murphy has an intriguing story.

He achieved financial independence at age 29, and he did this by applying a concept known as "expected value" to his online businesses.

In this episode, I chat with Billy about how expected value is more than just a formula; it’s a framework for how to evaluate your options; how to assess risk, reward, probability, and variance.

Let's back up a little. What is expected value? It’s the sum of all possible values for a variable, with each value multiplied by its probability of occurrence.

“Whaaaa? What does that mean?”

Here’s a simple example:
 
Imagine that you have a full-time job. You’ve also built a side business that’s earning $20,000 per year.

You’re trying to decide whether to stay in your full-time job vs. quit your job and focus on growing your side hustle into a full-time business.

You ask your two best friends for their opinion. One says, “that’s risky! What if you fail?” The other says, “you could become a millionaire! Whoa!”

You realize that both of those remarks are fueled by emotion and speculation. You want to make a more informed decision, so you decide to compare the ‘expected value’ (EV) of both options in Year One.

After assessing the market (e.g. studying customer demand, etc.) you determine that in your first year of running the business full-time, under best-case-scenario conditions, you could earn $250,000. There’s a lot of promise within your field; you calculate a one in four chance of this happening.

In worst-case-scenario conditions, you don’t make a dime of additional money; your business stagnates at its current income. There’s a lot of competition within your field; you assess that there’s also a one in four chance of this situation unfolding.

In middle-case-scenario conditions, you’d make around $100,000 per year. This is the most likely outcome, and you give it 50% odds.

What’s the expected value of diving full-time into this business?

EV of biz =

25% chance of earning $250k = $62,500
50% chance of earning $100k = $50,000
25% chance of earning $20k = $5,000

EV = $117,500

Okay, great. Next, what’s the expected value of staying at your current job?

EV of job = Salary + $20,000 in additional income

Of course, this is an over-simplified example, for the sake of illustration. Obviously, the decision gets more complex, because you need to account for future growth of your business — the 5-year outlook, the 10-year outlook — as well as future career growth potential within your 9-to-5 job. You’d also need to assess revenues vs. profit margins, etc., etc.

But this simple example illustrates the concept of using the expected value formula to inform your decision-making. Rather than just saying, “oh, that’s risky!” without any data, you can use EV as a starting point for a conversation about probability and risk.
The point is, when you're making a decision, your emotions and other people's opinions often override any rational thought you might have. Those emotions don't take risk or variance into consideration. Expected value does.

By running the numbers and identifying the worst-, mid-, and best-case scenarios, you can take calculated risks that have a higher likelihood of paying off.

Find out how Billy built a seven-figure business by applying this one incredible rule to his decision making process in this episode.

Enjoy!

-- Paula

Resources Mentioned:

• Billy's site, Forever Jobless

• Wikipedia - Expected Value

 

Find more about Billy Murphy and his podcast, Forever Jobless, in the show notes at http://affordanything.com/session56

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