ôô

How Expected Value Can Help You Make Good Decisions (Part 1)

If you want more success in your life, learn to take calculated risks when the outcome is uncertain. Get-It-Done Guy has a technique to help you make more good decisions.

By
Stever Robbins
Episode #313

 

The expected value of a decision is the sum of all the possible outcomes, with each outcome being multiplied by the probability of that outcome coming to pass.

Make Positive Expected Value Decisions

On the surface, it may seem like expected value only applies to cases where you make the same decision over and over. If you can flip the coin 100 times, then it makes sense to think in terms of expected value. But if you can only flip it once, you’ll make either $100 or $20; you won’t make $44. So expected value isn’t much use there, right? Wrong!

If you consistently calculate the expected value of each decision you make, any individual decision may work out or may not. But if you always decide to pursue options that have a positive expected value, over time, luck will work in your favor enough that you’ll get some real payoffs.

Do I Stay or Do I Go?

I’ve had coaching clients work with me on whether they should quit their job to start their own company. Should they leave a guaranteed $80,000 per year job to start something entrepreneurial? Let’s look at the expected value calculation.

A ballpark estimate is that starting their own company would give them a 10% chance of eventually making $500,000 per year, a 40% chance of making $100,000 per year, and a 50% chance of going bankrupt and making nothing. Personally, the 50% bankruptcy possibility would scare me into staying. But wait…

The expected value of staying at the job is 100% times $80,000 per year, or $80,000.

The expected value of my client starting their own company is 10% x $500,000 plus 40% x $100,000 plus 50% x 0. That’s $50,000 plus $40,000 or $90,000, compared to the $80,000 expected value for staying. The highest expected value choice is for him to quit and start his own company (even though the risk of failure is 50%)!

(Just for the record, he made over $100 million in his first 5 years and is probably going to be a billionaire by the time he’s 50.)

That’s where expected value makes the difference. It encourages taking calculated risks when the payoff is high enough and probable enough to make sense. A lifetime of positive expected value choices leads to more rolls of the dice, and enough big wins to offset the losses.

When you’re faced with a financial choice (or any kind of choice, really), don’t just think worst-case/best-case. Estimate probabilities and calculate the expected value of the decision. Pursue choices with the highest expected value. You will have plenty of losses and plenty of wins, but consistent positive-expected-value decision making will eventually pay off.

In Part 2 of this episode, we’ll delve into expected value in more detail. Remember to check out the interview with Billy Murphy at getitdoneguy.com/billymurphy.

I help high achievers accelerate or change careers. If you want to know more, visit SteverRobbins.com.

Work Less, Do More, and have a Great Life!

 

Pages

About the Author

Stever Robbins

Stever Robbins is a graduate of W. Edward Deming’s Total Quality Management training program and a Certified Master Trainer Elite of NLP. He holds an MBA from the Harvard Business School and a BS in Computer Sciences from MIT. 

The Quick and Dirty Tips Privacy Notice has been updated to explain how we use cookies, which you accept by continuing to use this website. To withdraw your consent, see Your Choices.