Afford Anything - Billy Murphy - Expected Value, or What Professional Poker Taught Me About Running a 7-Figure Business

Episode Date: December 19, 2016

#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 Learn more about your ad choices. Visit podcastchoices.com/adchoices

You can afford anything but not everything. Every dollar you spend is a trade-off against something else. So what decisions are you going to make? My name's Paula Pant, host of the Afford Anything podcast where we try to solve these questions. And disclaimer, I don't condone gambling. And I know you're thinking like, wait a whoa, whoa, whoa, hold on, hold on. Isn't this a financial podcast? What kind of finance podcast has to begin with a disclaimer that you don't condone gambling?

What am I listening to here? But bear with me. You'll understand why I just gave that disclaimer because today's guest is a former professional poker player. But I did not invite him on here to talk about poker. In fact, I don't know anything about poker. I don't know how it's played. I don't know what the rules are. But I was intrigued by his story. His name is Billy Murphy. And I was intrigued by his story because of one concept that comes out of the world of poker that he was able to successfully apply. to the world of business. And that concept is called expected value. Now, to be clear, expected value was not invented by poker players. Expected value is actually a statistical probability. It's part of probability theory. And the expected value of a given variable is the sum of all of the probable outcomes, each one weighted by the likelihood of its occurrence.

So in other words, the expected value is the mathematical expectation or the average or mean value of expectation of something happening. We're going to dive into this in today's podcast when I talked to Billy because Billy achieved financial independence at the age of 29. And he did this. He started off in his early 20s as a professional poker player. But after that, he left that world fairly early on when he was still in his mid-20s. From that point forward, he started a string of online businesses. And in his life as an entrepreneur, he used the concept of expected value. He used the concept of determining probability when he made business decisions.

And that's the key thing that I want you to pay attention to during this interview is the thinking process, the decision making process. Because expected value is a construct for how to assess risk. How to assess reward, how to evaluate your options, and how to think about probability and variance. Now, normally, I like to jump into the guest interview right away, but because we're talking about probability theory on today's podcast, I want to give a very quick, very simple example before we dive in, just so that in the hopes that this may make the conversation a little bit more clear. So here's a very, very simple example of expected value. And again, we're going to talk about this during the interview. Let's say that you're trying to decide whether to stay in your job or whether to start your own business.

The expected value of staying in your own job is your salary. It's the money that you make from your own job. The expected value of starting a business in year one, what is that? Well, let's say if your business does super, super well, you would make about $250,000. You've run some projections. And realistically, you think that in year one, in the best case scenario, you'll make $250,000. And you think that there's probably a one in four chance of that happening, a 25% chance. You also think if the business does okay, you'll make $100,000 in the first year.

and if the business doesn't do well at all, and let's say you've already got your first handful of clients going on, so you're already making maybe $20,000, so we'll just keep that as baseline. The money that you're currently making from your side hustle, $20,000 is what you would make from your business in year one if it doesn't grow at all. So let's say that there's a 25% chance of either of those extremes happening,

and the middle 50% chance is, that 50% in the middle. Well, what you would do is you would multiply each of those expected outcomes by their probability and the result is the expected value. And you could then compare that expected value of your business in year one to the salary that you're currently making and decide whether or not it is a positive expected value decision, a positive EV decision to leave your job this year in order to scale your side hustle into a business. Now, that's a very, very simple example. Obviously, the decision gets more complex because you need to account for future growth,

you know, the five-year outlook, the 10-year outlook, what is the opportunity cost of missing out on that compounding growth. But I'm giving that very simple example to illustrate the idea or the concept of using expected value to inform your decision-making rather than just saying, oh, that feels risky, or rather than just going off of your gut without any data to back it up. So that's what we're going to talk about in today's episode. And now that I've given that intro and given that example, hopefully that lays a little bit of the groundwork for you,

let's go into it. Let's talk to Billy Murphy, former pro poker player and serial online entrepreneur who reached financial independence at the age of 29. Hey, what's going on? Hey, how are you? I'm good, a long time. Thanks for coming on. I'm super excited to talk to you.

It was going to be fun. Yeah, you've got a really interesting background and a really interesting perspective. I want to talk to you about EV, but before we get into that, just tell me a little bit about your professional poker days. Yeah, that was the mindset that most people are like, what are you doing? Like, why are you getting into poker? It was one of those things I started, I started in college, and I was literally playing for pennies. And just trying to have fun, like just playing for fun. That was when it started getting popular on TV, the World Series of poker, and rounders came out.

And so I slowly started getting pretty good. And so I'd make a dollar here, a dollar there. And it was still very small money. But then I found out that people were making really good money. And so I would just ask them questions. How are you doing that? Should I read books? Should I read forums?

And so slowly I started getting a lot of resources that people taught me where to go to learn a lot about poker. And then I started making pretty good money where I never really had jobs. in college, I would just play poker for money. And I got out of college, took a job for a little bit, and then I decided to leave and play poker professionally. And pretty much everyone thought I was a little bit crazy. Like, wait, you just went to school for four years and now who can I gamble? But yeah, so I got into it, you know, already having played for, I guess, three years at that point. So I already knew what to expect. And, you know, I was still pretty green. You know, I was still playing for lowish stakes.

But I think by the time I graduated, I was probably at the point where I was making, you know, 15 bucks an hour. But I knew that there was a lot higher upside. I knew that, you know, people were making a lot of money. And I knew I was just scratching the surface. So, yeah, I went full time. I think the first month as a pro, I made $0. So it wasn't really, you know, my first month of the pro, I don't think I'd call myself a pro because I didn't make any money. But yeah, slowly started getting better.

I hired to coach my second month. And then literally every day, all day, I would just, play poker, go over hands, review hands, send hands to my coach, review his advice. In that second month, as a full-time pro, I made 17,000, and then just kind of kept hiring coaches, kept getting better, kept playing, and just kind of took off from there and did that for probably about four years. What made you stop? It became more of a job and less fun.

I would just wake up every day and look at cards all day. And so it got, I guess, a little bit unfulfilling that there wasn't anything more to it. I mean, yeah, you could, you know, making the money felt nice. But after a while, it just losses excitement. I think I'd always wanted to, you know, either invest and or start businesses. And so, you know, at that point, I'd made a pretty good amount of money from poker. And so, yeah, I just said, well, why don't I start looking into businesses or investing. And so, yeah, because I pretty much at that point played every day for seven years.

You know, it's because I was already playing in college and then four years pro. and so I'd probably barely taken any days off for seven years. And so it just got to be a grind. It was one of those things where it was probably one of the most fun jobs you could have, but it was still a job. Right. And at a certain point, you just burn out and then you want the next challenge. Yeah, I just lost its challenge.

And I'm sure I could have still gotten better and set goals and all that stuff. But it just wasn't one of those things that got me really excited anymore. Unlike roulette or Blackjack or just buying it. lottery tickets, poker is not a game of chance, it's a game of skill, right? 100%. Right. There's an old saying and all the poker guys say it a lot. People will say, oh, you're gambling or you're a gambler. It's basically like you're, well, it's only gambling if you don't know what you're doing in poker. Because like you mentioned, you gave some good examples of other games where you don't have an edge. You know, you have a negative expected value

when you play roulette or blackjack. I mean, even a good blackjack player who plays by the book is, you know, around a negative 1% expected value. And so what that means is if somebody's playing blackjack and they were, you know, a perfect blackjack player, but they weren't counting cards. Every time they bet $100, they would expect to lose $1. And, you know, it often confuses people short term versus long term because they don't see, they don't see what's happening. they just, you know, someone will go on a hot streak or a cold streak, and they don't realize there is no hot or cold streak. It's just, you know, variance. And the numbers will even out over time to bring you the expected value that the numbers basically say that you're going to get.

I always looked at my strategy in poker like this. I would maximize the size of the pot, you know, basically set my betting patterns against my opponent so that the pot got bigger when I thought I was ahead. I'd minimize the size of the pot when I thought I was behind. And a lot of times, you're scooping a lot of pots up that, you know, someone who doesn't play poker would look at as risky, like, oh, this guy's crazy, he's making all these bets and trying to win all these pots, but it's just a math game. And there's a certain expected value on every play on every decision that you're making. Sometimes they're going to go right. Sometimes they're going to go wrong. But, you know, if they're going right, 55% of the time, and they're going wrong 45% of the time,

or even if they're going right and wrong 50% of the time, but that, you know, the times when you're winning, the pots are averaging out bigger. And the times, that you're losing, the pots are smaller because the strategy that you've played against your opponents, those little tiny edges over tens of thousands of hands a month add up into a very, very good living. Can you explain? I guess can you define EV and explain what that is? Yeah, basically expected value and I forget the exact definition, but it's somewhere along the lines of basically there's an actual, it's the combination of all variables. It's basically the I think the way it's described as the sum of all possible variables.

On your blog, you defined it as the sum of all possible values for a random variable, each value multiplied by its probability of occurrence. That's a much better definition, yeah. So what does that mean? To the people who are listening, that just sounds like a whole bunch of jargon. What does that mean? What's the sum of all possible values of a random variable, each one multiplied by its probability of occurrence? So let me take a simple example like, you know, if you and I flipped a coin and it's heads and tails and

there's a 50% chance of each occurring. And let's say we each bet a dollar. So, you know, there's $2 total in the middle. Whoever wins gets the $2. Well, you know, it's a 50-50 chance. And so the expected value on that wager is going to be a dollar because there's $2 in the middle and 50% of the time you're going to win. So it's the 50% of the cost of the. $2 is in the middle. Where if you look at another example, like let's say a gumball machine, where if there was three blue gumballs and one white gumball, you know, you wanted to bet on the chance that, you know, you'd get a white one versus a blue one.

Well, that's going to be a different probability because you have a 75% chance of getting a blue one. And so if you were going to bet on that, then you would obviously want to bet on the blue one because you have a higher probability. Now what happens, and those are really simplistic examples, so everyone can understand them. But when you get into, you know, something like business or real estate or investing in, you know, whether it's stocks or anything else, of poker, there's so many variables that a lot of people think, like, oh, I don't know, let's just do this. And they just make a decision without

actually calculating the numbers where, you know, what I learned from poker is there's, there's an actual answer to what you should do. And I know that seems, that seems crazy because, you know, in poker, you can win or lose a hand. You still lose the majority of your hands. in poker, but even if I lose 60% or 70% of my hands in poker, if I'm putting all my money in when making the pot large when I have the odds, so basically your goal is to bet heavy when, you know, in poker or business and in real estate, bet heavy when the odds are in your favor. And so, for example, the gumball example, you would want to bet a lot of money when it's three

blue gumballs and one white gumball. Now, the way you could look at this in real estate, for example, if you had a killer deal that would just make sense to do, whether it's a small down payment you had to put down and the upside is large, there's a lot of equity in the deal, whatever it may be, the way that most people would look at that. And obviously, a seasoned real estate investor would be like, oh, I have to do the deal. But many other people, even if they're very, very smart people, wouldn't consider the expected value. They would look at it and say, wow, I don't want to risk my $10,000, so I'm not going to put it in. Where someone who understands the expected value would say, well, okay, maybe the deal is risky, but let me look at the math. Have I put in $10,000? And my upside on this deal is $100,000.

Even if I fail at this deal, 80 to 90% of the time, I still win or I still make my money back. and that's the way that most people look at it and say they look at the worst case scenario and they let emotions control their decisions instead of logic and they say I don't want to risk my 10 grand or whatever the amount of money is so I don't want to do that deal where somebody who consistently makes successful decisions and you know becomes very successful as a result or very wealthy they consistently make plus EV decisions and that means just constantly putting yourself in the situations where basically have a positive expected value from all the things that could happen in a deal or in a business. Some are obvious. I mean,

we give the example of if you put 10 grand and and you lose, you lose 10 grand. If you win, you want 100,000, that's very obvious bet. Most people would make that bet, even if they weren't real estate investors. But the closer you get to where people are unsure, usually they make the wrong decision. So most people on a daily basis make the wrong decision. Somebody might say, I want to be a millionaire. You know, they're in a job that makes 40 grand. a year and they're too afraid to leave their job and start a business or start real estate investing because they say, oh, that's risky because I can lose 40 grand a year. And the way someone who understands expected value would say, well, yeah, but every year that you decide to choose your job over something

that would help you reach your goal, like you're basically making a significantly wrong decision. Like, the job route is negative expected value. Like, no one who understands expected value would make that choice if your goals weren't going to align with the route you were on. So it sounds like the majority of people, as you see it, make decisions based on loss aversion. Yep. Whereas if you reframe your decision making in such a way that you look at all of the possible outcomes and the likelihood of each of those outcomes, and then you tell yourself, well, even if I fail the first time and the second time and the third time, as long as I, over the long term, as long as I win more than I fail, or as long as I win bigger than I fail, then that's positive. That's plus EV.

Right. 100%. And most people, so I look at it like a coin, right? So if it was a coin and your coin was weighted in your favor. and I said, hey, do you want to flip this coin with me? And every time we bet, you know, we'll bet $100. And your coin, you know, or heads on the coin is weighted at 51%, let's say, or 55%, whatever it is. You would never stop flipping against me. You'd flip all day long forever, as long as I would continue flipping because you're going to continually make money on that deal, on that bet. The way that most people do it is I don't want to risk $100,000.

$100 because what if I lose a couple times in a row, I don't want to play at all. And so most people never play at all and they sit out the game and they wonder why they can't get ahead. And I think it's, you know, most people also don't realize that every time you play the game, so to speak, whether it's business or real estate or poker, you improve. And the value or the odds on your coin, you know, I call it the entrepreneurial coin, they improve. So you get better. You understand how to make better bets. And whether it's going off for a higher expected value or just going after something that you'll succeed a higher percentage of the time because of your previous experience, it's something that most people don't consider.

And honestly, that's pretty much the way I run my life is like what is the decision I should make based on the logic. And is this plus CV or not? I find myself asking that a lot. It really clarifies decisions that most people just get stumped on and say, I don't know what to do about this. And if you ask yourself, what's the expected value of it, most people don't know what that is. But as soon as you show them like some simple math on their decision, lots of times it's a really clear decision, but they've never thought about it like that. Can we walk through an example of a time that you've used EV in your business? And there's one on your blog, when you talk about the, you ran this e-commerce store in one of your,

customers placed an order for more than $5,000 and asked if they could pay you 30 days later? Yeah. Yeah, I think one of my employees came to me, if I remember, and basically said, hey, we've got this big order. And I think most of our orders at the time were, you know, $100 or $150. And he said, hey, we got a really big order. But there's a problem. They don't, you know, they don't have the cash now. They usually pay on their deals in 30 days.

And he was all, I remember he seemed all stressed out about it. And I was like, well, okay, well, you know, what percentage of the time do you think that they'll pay? And he's like, what do you mean? I'm like, well, you know, do they seem legitimate? Like, you know, do they seem like they plan on paying? Is it a, you know, real business? And he looked it up and it was either a restaurant or a hotel or something like that that wanted to buy. And it was a heater business that we ran.

and so they wanted to buy heaters for their business and looked it up, they had good reviews and everything else. And so it seemed like a legitimate business. Basically, I calculated the math based on our margins. So on the $500, or the $5,000, I forget what our margin number was. You said a 25% margin. Okay, perfect. So I told them, like I said, well, you know, as long as we can, basically as long as the math checks out to where we'll make a profit on this, you know, over the long run. I told him I didn't care if they didn't pay us that one time, it was just bad odds because the bet made sense as long as they'll pay us the majority of the time. Like if they paid us 80% of the time and 20% of the time they totally stipped us, it's the right decision to take the order.

Where he was ready to cancel the order and I was like, what are you doing? And he didn't understand. And then I said, well, as long as they pay us, as long as they don't stiff us a large percent of the time, like it's clear that we should take it even if they are going to stiff as some of the time. So basically, even though you were looking at just one specific deal, one specific proposal, you didn't, even though you were literally only evaluating one deal, you didn't look at it in the framework of that deal in a vacuum. You looked at it in the framework of, okay, if this opportunity were presented to me a hundred times, and 80 of those times they paid, and 20 of those times they defaulted, would I still come out ahead?

Right. And then since the answer was yes, you went ahead with it, even though this is just one specific case study. Right. And the only time that I would say maybe you shouldn't do that is, like, let's say our entire business, the net worth of our business was like, you know, five bucks. Then it'd be really bad for us to go forward with that because that would run us out of business. So then we maybe look at an alternative. But otherwise, yeah, basically our life is made up of decisions like that that most of the time people are considering where if you just consistently make the right decision on them, over time you have significantly better results in other people just because you're making the right choice every time.

Like that was a profitable decision. It was a plus EV decision that I think some people in that scenario, like he was ready to cancel the order and tell them that we couldn't do it. and but if you went through your whole life saying oh I don't want to I don't want to risk losing on this deal we're just going to cancel it well you have lost because you lost the the positive expected value that you could have picked up on that deal the you know you had an expected profit on that deal and and I think he thought he thought they were going to pay 90% of the time or whatever the number was so you know he was willing to give up hundreds of dollars of profit on that order um and just expected value. Even if they stiffed us some of the time, we still had a, you know, a profit of, you know, I think hundreds of dollars on that, on that deal where most people would just consistently turn down something like that where, you know, if you do that, if you look at one decision in a vacuum and say, that's not a big deal, we're just not going to take it, don't want the risk.

But the problem is if you extrapolate that over, over a month or over a year, over 10 years, over your entire life, like the life of someone who consistently turns plus EV opportunities down and the person that says, I understand that's a plus EV opportunity, we have to do it. Their life's not even going to be comparable. Because over time, all of this plus EV decisions accumulate and sort of compound on one another. 100%. Yeah, the math works out. And I think poker really instilled that in me is like you can lose a hand. As a pro poker player, people often got confused. They'd watch me play a hand.

They say, oh, you lost. I thought you were a pro. I'm like, yeah, well, one hand doesn't, like, you're not playing for one hand. You're playing to win the whole game. You're playing to win over the long term. And I think that, again, most people are just so focused on the short term that they don't see that you're going to have ups and downs. But if you look at a poker graph from a professional poker player, their graph is

consistently up and down, up and down, up and down. but slowly over time you realize the graph consistently rises. So it's up and down, but it's on an upward graph. And so if you look at a yearly chart from a pro, you're going to have squiggles throughout the whole thing of their ups and downs, the short-term variance. But long-term, they're going to come out way ahead. And I think that's the way that most people get confused.

They say, oh, poker is a game of luck. And I would always tell them it's lucky. if you play one hand of poker, there's a ton of luck. Like, I have no idea what's going to happen on one hand of poker. For example, if you have the best hand in poker, somebody else has the worst hand, they still have like an okay percentage chance of winning that hand, which seems a little crazy, right?

But if you ran that same sample size for 10,000 hands, they're going to lose. And I think that most people say, you know, they see a result in poker or in business or in real estate. And they say, oh, like, see, I told you it was risky. Well, no, it wasn't risky. like it's just variance. Like there is some short term,

you can call it unluckiness, but it's really just the math. Like some deals are going to work. Some deals aren't going to work. But over the long run, as long as it was the right decision. So in poker, we were trained,

basically, like, we don't care. Like, I never cared what the result was. Did I make the best decision? Like, that was all that mattered. And as long as I was comfortable with the decision I made, I didn't care if I had a losing day or a losing week.

If I looked at my hands and I'm like, yeah, I think I played these well. I played these the way I was supposed to. I know that the math will work out. So the next week, I'll have a good winning week or the month will at least play out in my favor. It almost reminds me when you describe that chart, it reminded me of just a stock market chart, you know, where there's a lot of variance. There's a lot of that short-term volatility. But over the last hundred years of the U.S. stock market, the trend line is up. And a lot of people are afraid to invest in even a total broad market index fund because they're afraid of that short-term downside.

They're afraid that they'll put $10,000 in there. And then six months later, that $10,000 will be only $7,000 or $8,000. But that's variance. That's that short term. And if you zoom out and you look at the long-term trend, you just need to be right more than you're wrong and or write bigger than you're wrong. Yeah, no, that's a perfect example. I think the charts, yeah, would have a similar look to them. And I think, yeah, it's funny with most people who stay out of the stock market because, oh, it could go down any day. And it could. But while they sit out, you know, a lot of people have been sitting out since, you know, 2010, they don't want to see another crash. And while I'm sure there will be another crash or correction at some point, but then likely it will continue to go back up again and continue the 100-year graph. And, you know, those people that sat the sideline out since, and, you know, 2010 and you know kept the money in their bank making 1% or less on their money missed out on making 50% or 100% or whatever whatever the numbers have worked out to

and so they've played it safe so to speak but in playing it safe they also lost the game because they made a negative expected value bet by saying I'm going to put it in the in savings so I don't risk losing it but if they looked at it from an expected value standpoint they did lose they've been losing every day that they had the money in their savings account You know, I often get questions from readers or listeners who they want to know what the worst case scenario is. So they'll ask questions like, you know, have you ever had a nightmare, tenon? What was your worst rental experience? And that always struck me as the wrong question because that relentless focus on a isolated snapshot of the worst case scenario.

I mean, that's just not the profitable focus. It seems like the better question is, what is a possible? range of outcomes, what is the likelihood of each data point within that range? Yeah, 100%. When people start, you know, I have a group on Forever Java, as I help them launch businesses. And before they will launch a business, I say, what's the expected value of this business? And I have them go through a calculation of, okay, if everything fails, if everything goes horrible, and this is the percentage of time that I think that might happen.

Like, I don't know all the answers. So this is a percentage of time it could fail horribly. And they do a calculation on that. And then I have them do, you know, if you had a conservative estimate of how it's going to go, what percentage of the time do you think that's going to happen? And then I have another one where, you know, let's pretend you knock it out of the park and you'll have a huge success. What percentage of the time do you think that's going to happen? And each one I have them add up, you know, what would that equate to in terms of, you know,

if they calculated their margins, they calculated the amount of sales. And basically they'll come to an expected value calculation on, you know, the business of thinking of launching by breaking down a couple different scenarios and equating certain numbers to each one and coming up with an expected value calculation. I think, and I think people could do that in a lot of areas of their life. How do you determine the percentage of time or the probability that you will fail or succeed or wildly succeed? Yeah, it's hard. And a lot of that is most of it comes from due diligence. So the more due diligence you do, like if it's on a real estate project or a business,

You know, the more due diligence you do, the more data you have to work with. The more data you have to work with, the higher confidence you can have in your numbers. So, in other words, if someone was thinking about doing a real estate deal or, you know, starting a business, and they didn't look into it at all. And they just kind of like, oh, I heard this is a good deal. Like, the numbers look good. I'm just going to go ahead and do it. Well, for that type of thing, I would tell them, well, you should probably put a very high percent number to be conservative on that something could go wrong because you didn't do very much research. And so the more data they have where if they said,

okay, I got, you know, I got an appraisal, I got an inspection, I got, you know, I talked to the neighbors, I, you know, talked to the last tenants, I, you know, et cetera, et cetera, all of a sudden they could start saying, you know what, I have a pretty high confidence in this because I have tons of data to work with now where there's not going to be a huge, you know, they can still calculate, well, something could happen, downturn in the market, um, that kind of thing, but it's going to be a much slower number because of the fact that they did all their homework. So I always tell people, you know, the more homework you do, basically the more data you're going to have to work with, the more data you have to work with, the more confident

you can be in the expected value numbers. The more confident you are in your expected value numbers, basically the easier is going to be to pull the trigger and give yourself a green light to just pull the trigger on a deal that most people would have stayed away from. This seems risky. What would that due diligence look like if you wanted to start some type of an online business? Let's say an e-commerce website or an eBay or Etsy website or a blog. How would you gather that kind of information? Yeah. So I kind of go through a four-step process when I'm looking at a business to start.

So the first phase is, you know, is the product or service that I'm thinking about doing? Is this more valuable than what's on the market already? Because if it's not, then often what happens is it becomes much harder to compete. and if it's much harder to compete, you don't really know what's going to happen. So, you know, the first phase is basically I want to make sure what I'm doing is better than what's on the market. And it doesn't have to be better overall. It has to be, you know, for whatever gap in the market you're trying to fill, you want to fill that gap better than anybody. The second phase is marketing.

So even if you can fill that gap and you've got something that's amazing and people are going to want to buy it, if you don't know how to get in front of your customers, that's a problem. So the first two are basically really important. And I don't even go forward. If I don't think that I'll be able to do one of those things, it'd be very tough for me to want to move forward. The third step is, you know, kind of happens along, a long step's one and two, but it's due diligence. And due diligence is, you know, if I think I've got something that passes one and two,

I want to look at everything in the market. What are the competitors doing? How are they getting traffic? What do people think about their product? Do they have reviews on their product? What don't people like about it? What do people like about it? Where is this market going?

So I'm looking at anything and everything on the market and seeing, number one, that I'm right about my assumptions on steps one and two. And just to find out more. So, for example, this is where I'd be compiling a lot of my data for an expected value calculation. So if I find out that, oh, look, all my competitors are doing a million bucks a year. Like now I've got an idea of, okay, there's, you know, I'm offering a similar product, but mine's better.

And these guys are all doing a million bucks a year. or if I looked into a business and nobody's making any money, everybody's making 10 grand a year, I'd say, oh, okay, is there money to be made in this business because everybody else is making nothing? So that helps get an idea on where the money is in the market and what people are doing to do that, whether it's on their product or service, whether it's on the type of marketing they're doing, is there marketing gaps that you could fill that others aren't filling? And then so I move forward into phase four, which is the expected value calculation. I say, great, here's all the data, here's what other people are doing, here's how much they're making

from what they're doing, here's what I'm going to do differently, here's how I'm going to market differently, here's how I'm going to offer my product or service differently, and that's kind of how I come up with, okay, how confident am I that I have all the data, I have all the numbers, how confident am I that my product or service is more valuable? You know, have I tested it? If I haven't tested it, is I still really confident or is that going to lower my percentage of confidence in the fact that I really have solved for value and it really is more valuable than my competitors. Same for marketing. Am I confident that I can get in from my customers? You know, have I tested it? If I haven't tested it, am I confident enough that based on what my competitors are doing and my

experience in marketing, can I beat them? You know, can I do a better job of getting in front of the customers or get in front of them more cheaply than they are? And so, you know, based on all those things, I put together a calculation. And I usually do it in three different brackets. You know, the likelihood that I'll have a huge success, the kind of conservative success, and then huge failure. And I'll kind of equate three different numbers of percentage of time that I think those might happen. And you'll come to an expected value calculation. And so it helps a little bit if you have a couple different business ideas you're pursuing, for example. And let's say your goal is to make $100,000 a year, you would want to run a calculation like this to,

if you've got three or four ideas you're thinking about, I would run a calculation and say, well, I want to make sure that the ideas I'm pursuing are in that range because if you run the expected value on something and it's going to make 20 grand a year and your goal is 100 grand a year, well, that's not a good idea because you're never going to hit your goal with it. And so most people, I think, blindly jump into certain projects just kind of like blindly hoping that they'll someday magically wake up and be at their goal. And I'd just like to do that ahead of time. Right.

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How do you adjust for variance? And I guess before we answer this, we should probably define for the people who are listening what variance is. Yeah. So variance is basically, it's a, and there's another one, I don't know the perfect definition. on it, but variance is kind of like the short-term swings. So the ups and downs, so to speak, of whether it's the market, real estate market, stock market, poker hands, business. So there's wins and losses. You're going to have both. And so, yeah, when people talk about short-term variance and poker, everybody said, oh, you're just having some short-term variance, it means, you know, the math wasn't working in your favor in the short term, but as long as you're

making the right decisions, it'll even itself out in the long run. But you're still going to have those ups and downs. Right. Like if you go to the coin flipping analogy and you just take a normal coin, 50% of the time it's going to be heads, 50% of the time it's going to be tails, but it's entirely possible that you might flip a coin 10 times and it'll be tails all 10 times in a row. Right. 100%. I'll give you a real life example of this is before I understood expect of value, I was in high school. And I lived in upstate New York. We were close to an Indian reservation. So they were allowed to have casinos there. So when you're 18, you can go gamble and play in a casino.

And so I would go there, and it was just exciting. I enjoyed kind of the rush of it. And so I played roulette, and obviously that's a horrible, expected value game, but I didn't understand it at the time. I can remember going there, and I was betting all my money on red, for example. And so I'd bet on red, and I'd lose. And so I would bet again on red, and I would bet, doing something called the Martingale strategy,

where you double your bet. So, for example, I'd bet on red with a dollar. I'd lose, and the next time I'd bet $2. And I'd lose the next time I'd bet $4. I'd lose the next time I bet $8. And in my mind, I was like, well, oh, I'm definitely going to win a lot of money doing this because, you know, and I can't lose because there's no way it's going to be black, you know, X amount of times in a row.

And I remember I lost something incredible, like 14 times in a row or 18 times. It was such a, like, such a, you know, that's very, you know, that's very, variance. Like I lost, which at the time was a ton of money to me like $300 or $500, whatever the number was. And I can remember just thinking like, oh, like what happened? Like my strategy didn't work. And obviously I didn't understand that like the math, like each time I was making a horrible decision, like what color it came. The math didn't change based on the color it came last time. Like the math didn't care what color was last time. The math was still the same. I still had, you know, relight. I think you have closer like a negative 5% expected value every time you bet. So I was just losing every time I didn't understand it. But. But that was an example. That was my big lesson in variance that even though I was betting at something I, you know, I think betting on red and black is a, you know, a small negative expected value.

But basically getting, you know, having it come black 14 times in a row or whatever the number was, like that's variance in real life. So variance is normal and it happens. But the way that variance can sometimes white people out of the game is if the string of battle, luck goes on for so long that it takes you out of the game, that it just, it wipes you out. Yep. It's one of, one of many reasons why the house always wins. You know, not only does the house have positive EV games, but in addition to that, the house can also withstand variance for a lot longer than any individual could. Right. So as a business owner or as an investor, as a regular

person, how do you put stopgaps in place to make sure? sure that variance doesn't wipe you out, that a long string of bad luck doesn't wipe you out. Yeah, that's such a great question. In poker, we called it bank role management. So in poker, I believe at the time when I was playing, we had something like a, like the recommended bank role management was for whatever game you were playing, you wanted to have at least 20 buy-ins. So a buy-in is basically, you know, if you're going to buy-in for a maximum of $500 in a game, So if you had a 20 buy-in rule, you would want your capital to be at least $10,000. So in poker, you called it a bankroll, in real estate or stocks or something, you call it your capital or your total investment account.

But in poker, that was the way to beat the short-term variance. Because, for example, if I lose a couple of hands in poker, I can lose all in a couple times in a row, not a big deal. And you lose a couple grand. But if your whole bankroll was a couple grand, you're out of the game. and now now you don't have any more bets to make where you can make positive expected value bets. You're totally out of the game. So your expected value is now zero. And so when we look at this in business or investing, you want to have enough money so that you can keep playing the game. Now, it doesn't mean play so safe that you've got all your money in cash

in case something comes up. But even if you look at insanely successful investors like Warren Buffett, he keeps a ton of money in cash. And the reason he does that is because when it, an amazing opportunity comes up where he can make significantly better returns than a normal investment, he wants to have the capital to do it. And a lot of times, nobody else will have that kind of capital available, but he will. Another term a lot of people use is risk of ruin. You want your risk of ruin to be very, very low or zero. So for example, if I'm thinking about starting a business and I don't really know what's going to happen, it could be risky, I probably won't put all my chips in because then I'm completely out of the game and I need to

basically go work a job or go raise money or do something to get back into the game. And then I've lost six months or a year or two years of income because I can't play the game. And so I think that's something people don't keep in mind is people think about starting a business. And they have two weeks living expenses. Well, it's a really bad decision. In poker, I think the rule was, you know, the general rule was have a year of living expenses, six months to a year of living expenses and 20 to 30 buy-ins for your bankroll management. And that way, you never have to dig into your investment for living and you can withstand the variance to where you can always play the game.

Oh, that's really interesting. Have six to 12 months of living expenses and 20 to 30 buy-ins. So basically have enough money to take care of yourself. And in addition to that, enough money to, in a separate pot, enough money to, quote unquote, invest, so to speak, to take that analogy into a different arena. Yeah. And that perfectly translates to the world of starting a business or investing in. real estate, you know, have enough money that you won't be eating dog food plus an additional pot of money separate from that that you could continue to make investments, continue to start

businesses, continue to just pursue projects that could be profitable. Yeah, and I think you brought up such a great point. The bankroll management or the thought that some people don't think about that and they go broke, you know, poker players, investors, you know, business people, they don't think about the chance that they could be completely wiped out in the number. flip side, a lot of people play it so safe where they have too much, you know, they go overboard on, okay, I don't want to go broke, so I'm going to save up so much money that in both scenarios, they're making negative bets. One of them is going to have kind of that one short term variance that wipes them off completely. And the other one's going to have, it's almost not noticeable

because everything's kind of going the same all the time, but they're just making small negative bets over and over and over and over that I think, you know, there's a term I, I, use, I call it monopoly money, that if you have a certain goal and you know the goal you want to hit, let's say you want to make a million dollars. And, you know, let's say someone makes, you know, 100 grand a year they're taking home. The way a lot of people would look at that is I'm going to just save all the money. That's probably a bad example. Let's say they take home 20 grand a year. They take home 20 grand a year and they say, I'm just going to save this money because I don't want to lose it. And if their goal is a million dollars and they're only taking home 20 grand a year,

they don't do the math to realize they're either never going to hit their goal or it's going to take them a very, very, very, very long time to hit their goal to where they're not even going to be able to enjoy hitting their goal. Like they'll just be so old that they won't get to do anything with it. Where, you know, if you just look at it like the way I often look at things is if you know your goal and the way and kind of how bankroll management plays into this is you should have a certain amount. of money to live on. And besides that, if you know your goal, the rest of the money should be treated as monopoly money to try and hit your goal. Because if you're not hitting your goal,

you know, by playing it safe, all you do is you guarantee you don't hit your goal or you make the game so long that you don't get to enjoy it when you do hit your goal. On the flip side, let's just pretend that you treated all other money besides your main living expenses. You put away a year of living expenses and just say any other money that I have, I'm going to use this money to make positive expected value bets to make sure I hit my goal, I would guarantee that person over a three year, five year, 10 year period will hit their goal because they're making consistent bets that are positive expected value and the math will add up to where they'll hit their goal. And I think that most people don't do it like that. They make 20 grand or 50 grand or 100 grand and they put it in the

bank and they look at it as like they're safe. I need to protect it. I need to keep my money safe. but all they're doing is guaranteeing that they don't hit their goal because they're not using that money to make positive expected value bets to help them achieve what they want to achieve. Interesting. Have enough set aside that you no longer have the risk of ruin. Have enough set aside that you can stay in the game. And then besides that, the rest of it is monopoly money. Yeah. And I think if people played the game like that, if you and I were sitting down and playing monopoly, we would both be. trying to win the game. We'd both be investing in properties so that when the other person lands on it, we'd want to charge rent. We'd want to put hotels on there. In real life, people would land on a property and have the chance to invest on a good deal. And they say, you know, in monopoly money,

it's easy to buy that deal. In real life, they say, I don't want to risk it. I want to keep my money in the bank safe. But they guarantee, you know, if you played monopoly like that, you would never win the game. You'd lose 100% of the time. But because people can play a game, logically, but when you bring it to real life, they start playing emotionally and they don't make the right decisions. So yeah, if everybody treated their money like Monopoly money, and I'm not saying make wrong decisions, like you said, they could put a year of money away and just make the right decisions. If people treated their money like Monopoly money, I guarantee you with 100% accuracy over the long run, again, dismissing short-term variance because short-term variance will happen

to everyone. But over the long run, everyone would be more successful. Right. All right, final Before we wrap up, how do you apply these concepts when you're thinking about diversification? For example, you're looking at some business opportunities, but you're also looking at the opportunity to invest money in a 401k in a total stock market index fund. And then you're also looking at maybe some rental properties. You've got all these options arrayed in front of you. How do you apply these concepts there? Do you throw all your chips on the one that you think has the highest EV or do you spread them out? For me, it depends.

I'll often place money where I think it has the highest expected value, but it depends on the goal. So it depends on my end goal. For example, I have almost a million dollars in one specific stock right now. And most people would look at that as that's stupid. Like, that's really dumb because I could hit short-term variance and something could go wrong. I could lose my money. But I looked at it as well, based on what I know, this is a higher expected value of other places is I could currently put my money.

And I could end up being wrong and not doing as well. And that could totally happen. And it will happen a certain percentage of the time. But the way I like to look at it is, and I think, I don't know if it was Warren Buffett or somebody else with this quote, that I prefer, I'd rather invest all my eggs in one basket and watch that basket very closely than spreading things out. And the more you diversify, the more you basically, you're losing on bets, but they're just spread out. So for example, and again, I think this is Warren Buffett made a good quote that,

you know, if you had a couple of different investments, if you had 10 investments, I'll say, essentially, if you're putting money into 10 different investments, the 10th best investment, like, why are you investing in the 10th best idea instead of the first best idea? And that's a way to look at expected value too is that the one that you think is going to do the 10th best, it's a negative expected value bet if you could have put more money in the first one. I think this ties back into the risk of ruin. As long as you're not in a situation where if you lost it all on that bet that you're in a bad place, I think it's okay to put all your chips down or a lot of your chips.

Because for example, if that stock went to zero, I'd still be fine because I have plenty elsewhere. But if I, you know, if that was, if my whole future and had a family and everything was riding on like only that one thing, I would probably diversify somewhat because, you know, my risk of ruin again. But yet for the most part, and you see this in business all the time too, is, you know, someone will start 10,000 of those like micro blogs, you know, they make a dollar a day or, you know, a couple cents a day and they just start thousands of them, affiliate link blogs. And if they instead put all their energy into one, they would likely make significantly more money because they're not spending all their time on their thousands best idea rather than just their best idea. They're putting all their time and energy into that one. They'll make way more money. Now, in the short term, like today or this week or this month,

maybe they wouldn't. Maybe something would happen where they wouldn't make the deal needed for that deal to go well. But over the long run, I believe that consistently betting on your best ideas, whether it be best investments, best businesses to start, you'll do significantly better. And so I think that at least for me, I try to limit the amount of things that I'm putting time or money into. Perfect. I like that. All right, we'll wrap up there. Billy, where can people find you if they want to learn more?

Yeah, they can go to foreverjobless.com, and they can check out. The blog is foreverjovless.com slash blog. And yeah, feel free to read the articles there and reach out with any questions. And you have a podcast as well, yes? Yes, Forever Jobless podcast. It's, I'm doing it in seasons right now. So right now we're, we haven't recorded for a while, but we're probably launching the next season, probably sometime in quarter one. What are some of the chief takeaways from this conversation that we just had? Well, for me, there was one primary takeaway. And that is that when you're making a decision about, for example, whether or not to quit your job,

whether or not to start a business, whether or not to try to up-level a business that you already have, whether or not to buy an investment property, when you're making these decisions, it's often too easy to get swayed by people's opinions. people will say things like, well, that feels really risky or what if it doesn't make it? Or I have, you know, people will express emotion. And that isn't the best way to make a decision. Or more specifically, that isn't the best way to properly evaluate the risk and the volatility or the variance within that decision. The way to evaluate risk is by looking at possible outcomes and then looking at the

at the likelihood of those possible outcomes, and then asking yourself, can I live with the worst case scenario? Not do I want the worst case, obviously, but could I live with the worst case? And do I have a decent likelihood of achieving the middle case or the best case scenario? And if you are in that situation, if you can live with the worst case, meaning variance doesn't wipe you out, it doesn't kick you out of the game. And the middle case or better case scenarios would put you in a position that is more desirable than where you are today, then that might be a plus EV decision. In other words, if you continue to make calculated risks, protecting yourself from downside while exposing yourself to the potential for upside,

then even if you have to take some small losses, even if not every shot works out, over time, over the long run, you will most likely be in a better position for the fact that you have taken those calculated risks. So that's the key takeaway that I got from this conversation. To paraphrase Warren Buffett, be neither greedy nor fearful,

don't be paralyzed by fear of risk and of downside and of a singular loss, assuming, of course, that you can handle that loss and it doesn't wipe you out of the game, assuming that you can survive the variance. And on the flip side, don't be so compelled by big dreams or big greed that you shoot for something without adequately looking at realistic outcomes of that thing happening. In other words, just take a more structured, more disciplined approach to assessing risk and do this with business, with investing, with any decision that you make.

So that's the major takeaway that I got from this conversation with business. I'd love to know what you think. You can get the show notes at afford anything.com slash episode 56. Again, that's afford anything.com slash episode 56. We still have our previous website, podcast. offordanything.com. That's up to. But that's just a simpler way to get to the show notes.

While you're there, you can read a summary of today's interview, have some notes that you can keep with you, and also leave a comment. Let me know what you thought. Are you going to use expected value when you're making decisions? And if so, how? And which decisions? My name is Paula Pant. You're listening to the Afford Anything podcast.

Thank you so much for tuning in. By the way, tune in next week. We're going to be talking to Philip Taylor, P.T., the founder of FinCon, about money lessons that he's learned after having surrounded himself with a bunch of personal finance nerds for a decade now. So tune in next week to hear our conversation. with PT and I'll catch you then. Take care.