👆🏼(Google Sheet Template included below) 👇🏼

♦️ Today I want to talk about the tool I extensively use in my analysis whenever the situation requires predicting measurable (usually financial) outcomes. It is dead simple to use, yet probably one of the most impactful ones.

♦️ I'm talking about Expected Value (EV) - the average expected financial outcome of a decision. It is calculated by multiplying all the possible payoffs by the probability each will happen and summing the answers.

♦️ For example, if you have a coin toss bet, and you win $100 if a coin flips to "heads," then the expected value of the game is 50% times $100, or $50. Simple. Now, what if "tails" loses your $50 in turn? The expected value of such a game will be $100 x 50% plus -$50 x 50%, or $25. Still good, right? But let's rig our coin and make it flip heads 20% of the time and tails 80%. What we'll have is $100 x 20% plus -$50 x 80% or -$20 as an expected value of the game that you probably shouldn't play.

♦️ Another example. Let's say you're up to leaving a cozy cubicle with a guaranteed $200K a year and starting your startup. The chances of getting any payoff in the first year of a startup development are low, but then they can gradually grow. So, let's look into a five-year perspective for your company compared to keeping a comfortable job.

♦️ The expected value of your current job will be $200K x 5 years x 100% (arguably), or $1 million assuming you don't lose your job. But let's be more honest and say there's a 70% chance of $1M, 20% chance of $800K, and 10% chance of $500K. The sum of these multiplications will give you $910K of the Expected value. Note - probabilities should sum up to 100%.

♦️ In turn, let's say there's a 10% chance that your startup will bring you $10 million in five years, a 40% chance of getting $3 million, and a 50% chance of making nothing (startups are tough). Thus, it is $10 million x 10% plus $3 million x 40% plus $0 x 50%, or $2.2M. So, it'd be statistically better to say goodbye to your boss and start the venture. (Note, I'm not talking about mental health here, just 💰)

♦️ Monetary value is not the only thing you want to consider when making a life-changing choice. Sometimes we do things for financial gain, and that's great. But if you're faced with a difficult financial decision, calculating the expected value might help you make a better one that's clear from your fears and cognitive biases.

♦️ ****Here's a simple Google Sheets Template I put together for you to calculate the EV at a particular time horizon. You can use it for pretty much any financial decision. Just make sure to get the probabilities as close as possible to reality, and don't forget to re-evaluate them as new data arrives.