Back in 2005 I went to Las Vegas for a 10 day solo poker trip that would see me return home with a massive desire to travel the world and a bank account that was down €4,500.
I viewed the price of this trip as an “education” that would someday hopefully stand to me.
During the following eight years, I played poker both online and live (not as much as I had initially planned). I studied the game by reading a ton of books related to the game and also created a small poker club locally from 2006 – 2013.
Image credit: Danny Maxwell (Pokerstars Photographer)
While reading these poker books and following various podcasts, I kept hearing of the term EV.
Before I explain what EV is for those of you who’ve no idea what I’m talking about – let’s back up a little.
Most people make negative -EV decisions instead of making positive +EV decisions in their daily life. The end result is that these people potentially miss out on making money. Growing up and living life as young adults, we’ve been subconsciously conditioned to “avoid risks”, because taking risks leads to greater variance in ones life.
The reason I’m writing this post is to show you how to think about decisions, both in business and personally while keeping “EV” in the equation. By understanding what EV is and using it to its full potential when it comes to your business decisions, you can undoubtedly make more money.
What exactly is EV then?
EV is Expected Value.
Nice and simple, eh?
That’s the short version. The longer and more accurate version of EV is – The sum of each possible outcome for a random variable, multiplied by the probability of the outcome actually occurring.
If you’re still lost, then don’t worry. I give you some real life examples below to hammer home what I’m talking about.
The easiest situation to give an example of EV in action would be to flip a coin.
Here’s how it fairs out:
You and a friend each make a bet of €1. Your mate picks tails and you pick heads. Whoever wins the flip takes the €2. Each of you have a 50% chance of winning every time, therefore your EV is €1. You’re risking €1 and since there is no edge on the bet – it’s neutral EV.
Now, I’m going to give you an example of how EV works from a poker standpoint, but you can skip this part if you don’t understand anything about poker as there will be examples that are easier to understand after this one.
Poker is a game that I perceived as 100% luck before I started to play and study it. Without knowing how the game works, you’d probably think it’s nothing but luck as well. However, it’s a game of skill in the long term and once you understand how EV works, then you’ll start to see how the good players can squeeze money out of the inexperienced players from tiny (EV) edges.
The next example is a basic poker situation that players who know the game will understand, while those who have no idea of what’s going on will most likely see it as stupid/silly.
Let’s say that there’s €50 in the pot after I raise pre-flop and one player calls. The flop comes down and I’ve got nothing. The guy who called me taps the table to signify a ‘check’, and I bet €25.
You may be thinking, why would you bet if you don’t have a hand?
The reason behind the bet (aka continuation bet) is that I’d do it if I thought it was a +EV move. I’m risking €25 to win the €50 that’s already in the pot. The reasoning behind this logic is that if I have a feeling that my opponent is going to fold more than 33% of the time then I have to bet. You only have to win once out of every three times in order to break even.
On the other hand, if I think he would fold his hand less than 33% of the time, it wouldn’t make any sense to bet €25.
Now, those that don’t understand the logic behind this move would probably see this as a stupid play and think “what if the guy had a hand?” These type of questions don’t matter when it comes to making a +EV move. Players who know about EV would not pass up this opportunity to bet €25 in this scenario.
Breaking things down further for this example, let’s assume that the player would fold his hand 40% of the time.
So, you’d lose 100% of the time when he calls (obviously you wouldn’t lose 100% of the time, but this is just to keep the explanation as simple as possible).
If both of these things were to happen, then the result would be as follows:
60% of the time – you’d lose €25
40% of the time – you’d win €50
60% of (€25) = €15
40% of (€50) = €20
€20 – €15 = €5
EV = +€5
So your EV from making this bet is €5. It doesn’t matter if you actually lost this hand or not. Your EV is a positive €5 in the long run. It’s these situations that can make players a lot of money.
In the end, a player who is trying to avoid losing money will miss out on these +EV opportunities at the table. Just like in business – playing not to lose money can ultimately increase the chances of you losing money.
Ok, enough about the poker side of EV – this article is about applying EV to your business, so let’s crack on with it.
Using EV for rational decision making
I’m going to give you an example of a situation where we personally missed out on a potential opportunity two years ago – before we started to think about decisions in EV.
We were looking to buy a website that would allow us to dip our toes into the affiliate/e-commerce industry and we found a website for sale on flippa.com for €3,000. It was making an alleged €600 each month in advertising and affiliates. I remember scratching my head and thinking “why is this guy selling a site that’s making easy money?”.
I thought that there must be a hidden reason for him wanting to sell it. Without any idea of how to do a proper background check into the website (lack of experience on my behalf), I let the opportunity slip by without a second thought.
Looking back on this inexperienced decision, I ran the numbers using the EV method I’ve described. What was the worst thing that could happen if I pulled the trigger and bought that website?
We’d lose €3,000.
The best thing that could happen was that we’d have a site that makes on average €7,000 each year without much work.
So, was it the correct decision?
Here’s the numbers crunched using our EV calculator method based on the principle that we’d lose all the money 50% of the time:
50%: – €3,000
EV = +€4,000
So, as you can see from this simple equation – even if we got scammed 50% of the time and lost all our money (which wouldn’t happen, obviously) our EV would still be +€4,000 on the deal. These calculations don’t factor in the times when we don’t get scammed and the site makes money in the long run.
Even though we more than likely made the wrong decision when it came to this website, we’ve been able to learn from our mistakes and have applied EV theory to other future decisions.
Emotions got in the way…
It’s hard not to let emotion get in the way of you making a financial decision. Our initial thought about buying that website was that there must be something wrong with it. If we’d applied EV, maybe we’d have viewed the whole process differently – who knows!
By consistently making +EV decisions going forwards, you’ll slowly carve out a nice edge over time.
Another example of how you could apply a poker mindset using EV to your business is as follows:
You are deciding whether or not to get a full-time job or start up your own business that’s based around what you’re currently doing. The first thing to do would be to make some calculations about what your salary would be from the full-time job and then compare it to what the potential EV would be from starting your own business.
The thought process for many people is like this: “If I get a job, I’ll make about €40,000 per year, but if I start my own business I could make more, but I could also make a lot less money. This is a little risky”.
This line of thinking makes sure that you never extract any +EV from the decision – much like our own personal example above in relation to the website.
Using the new EV method, here’s how you should be analysing a situation like this:
“Ok, so if I take this job, I’ll make €40,000 a year, but if I go with my own business my EV is about €65,000. (This figure is based on estimated income and the estimated asset value, all calculated at a very conservative multiple).
If the business doesn’t go as planned then I have X amount of savings behind me which would allow me to get by for X amount of weeks/months until I absolutely must find a job to survive. Therefore, creating my own business is the correct play”.
The amazing functionality of EV is that you can always go back to the -EV option (getting a full-time job) if the +EV route (creating your own business) didn’t turn out the way you wanted. Despite what you may think, there are tons of jobs out there for you to find. Unfortunately, most people choose the negative -EV option first and plan to take a shot at the potential +EV opportunity someday down the line.
Don’t be afraid to take calculated risks…
As you know perfectly well – there’s nothing guaranteed in life, so you’ve got to take the chance when it comes along.
If our online endeavours suddenly stopped for some reason, then we’d use our savings to figure something else out. If nothing came of that, then we’d choose to start over and go from there.
There are always options out there for you to take. It’s only a matter of thinking things through first and formulating a plan.
The last example I’m going to detail is another personal story – but this time we applied our EV thinking to the process and made a calculated decision.
Back in July 2014 while we living living in Paraguay, we were contacted by a company from the US who wanted us to provide them with 60 blog posts for their website. The total order was for €3,000. They wanted us to send them all 60 posts first and then they would pay us when they received the batch.
Before we started applying EV to major decisions in our business, we probably would have asked for a 50% upfront payment on this order as it was going to cost us €1,500 on outsourcing costs to our team of writers.
Obviously this was a nice chunk of profit to make, but it also meant that if we were ripped off we’d be down €1,500 of our own money.
So we looked up a few details about the company online just to see if they sounded legit. Based on our margin of 50% on the order (€1,500 profit) we figured that they would pay us greater than 80% of the time.
50% margin = €1,500
If we assume that they didn’t pay us 20% of the time, we’d lose €1,500 when that happens.
The calculation is as follows:
20% of €1,500 = €300
80% of €1,500 = €1,200
The EV to come out of this deal was: +€900
When you look at the EV (€900), the decision to provide them with the order and get paid at the end was an easy decision. We were also pretty certain that the actual percentage of the time we’d be ripped off was much, much lower than 20%, but we went with a conservative figure.
We made the deal and got promptly paid at the end by the company, who’s turned out to be a regular client of ours since then.
It’s easy to opt for the -EV route because there’s less risk involved. This mindset can lead you away from the +EV path indefinitely.
To rap things up here, you only need to take away the following from this article:
Start making +EV decisions from now on. If you don’t, then you’re waiting for an opportunity to fall onto your lap. That means waiting for the “perfect” moment to come around. This is a situation that seldom happens for 99% of the population.
A lot of people will unfortunately refuse to take the +EV route before they even compare the figures, as all they see is the risk.
By using these quick EV calculations, you can get a better idea about things – rather than just going with your instinct all the time. Obviously, you’d want to weigh up all the factors before making a big financial decision.
If you think about it; choosing the negative -EV option consistently is a lot riskier at the end of the day.
I came across a great quote the other day which I think is a perfect way to end this article;
“The most dangerous risk of all – The risk of spending your life not doing what you want on the bet you can buy yourself the freedom to do it later”
Hopefully those of you that stuck with me until the end can understand the EV concept? If you’ve any questions, then pop a comment below.