MBS Accounting is a CPA Practice
Mathematics of Money Management (MMM)
A lot is written and said about money management. In most cases though what is really talked about is budgeting. What is often overlooked is the critical step before budgeting.
The absolute key question which will determine whether you maximise your wealth potential over the longer term is the following
"What is the ideal amount of my risk capital to put into that investment."
The correct mathematical answer to that question will also tell you whether you can afford to make that investment and how much should you borrow if at all.
At first glance you might think this question is a no brainer. If I have profitable system whether it be in trading shares,property developments etc then surely the more money I invest in it then the more I will make. BE AWARE this will only hold true if you never make a loss on a single 'trade', 'development'or 'deal'. Otherwise such an attitude will send you broke even if you are very good at what you do.
MMM will tell you what is the optimal percentage of your risk capital on an investment whether it be shares, property investment, franchise etc based on the past track record of that investment. MMM is about the balancing of risk and reward to maximise return over the longer run. Human nature is to fight or flight by either taking on too much risk and get it over and done with or to take on no or too little risk.
Here is a test of how good your MMM skills are. If I was to say to you that I would toss a coin ten times. If it came up heads I would
pay you 200% of what you bet and if it came up tails you would lose 100% of what you invested. Sounds like a pretty good system and it is. An average return per coin toss of 50% of your investment. The key question though is what fixed percentage of your risk capital to invest on every coin toss.
Your instinctive gut reaction compared with the optimal percentage will tell you where you lie on the total return bell curve, are you a gambler, a mouse or right on the razors edge. Once you know where you lie on that risk/reward curve you can take remedial action to get you closer to the cutting edge. If for example you are a property developer and have been involved in five past property ventures and made the following results 80%, 5%, 20%, 35% and 15% then MMM will tell you what percentage of your risk capital net wealth to invest in the next property venture assuming the developer is confident that his past track record will continue. The optimal percentage is continually adjusted when the latest 'result' is known.
MMM clearly demonstrates that the first question any investor ought to ask when looking at an investment is not 'how much can I make' but 'how much could I lose'. The variable that has the greatest inpact on the opitmal percentage is not the % return you make when you win but the % losss you make when you lose. Preservation of capital is the key priority, once your shooting blanks your out of the game and there is no way you can win,
I hasten to add that I am not a licensened financial adviser. I will not recommend one investment over another on some non mathematical personal opinion basis. All I will give you is the mathematical information to aid in your decision making process.
The absolute key question which will determine whether you maximise your wealth potential over the longer term is the following
"What is the ideal amount of my risk capital to put into that investment."
The correct mathematical answer to that question will also tell you whether you can afford to make that investment and how much should you borrow if at all.
At first glance you might think this question is a no brainer. If I have profitable system whether it be in trading shares,property developments etc then surely the more money I invest in it then the more I will make. BE AWARE this will only hold true if you never make a loss on a single 'trade', 'development'or 'deal'. Otherwise such an attitude will send you broke even if you are very good at what you do.
MMM will tell you what is the optimal percentage of your risk capital on an investment whether it be shares, property investment, franchise etc based on the past track record of that investment. MMM is about the balancing of risk and reward to maximise return over the longer run. Human nature is to fight or flight by either taking on too much risk and get it over and done with or to take on no or too little risk.
Here is a test of how good your MMM skills are. If I was to say to you that I would toss a coin ten times. If it came up heads I would
pay you 200% of what you bet and if it came up tails you would lose 100% of what you invested. Sounds like a pretty good system and it is. An average return per coin toss of 50% of your investment. The key question though is what fixed percentage of your risk capital to invest on every coin toss.
Your instinctive gut reaction compared with the optimal percentage will tell you where you lie on the total return bell curve, are you a gambler, a mouse or right on the razors edge. Once you know where you lie on that risk/reward curve you can take remedial action to get you closer to the cutting edge. If for example you are a property developer and have been involved in five past property ventures and made the following results 80%, 5%, 20%, 35% and 15% then MMM will tell you what percentage of your risk capital net wealth to invest in the next property venture assuming the developer is confident that his past track record will continue. The optimal percentage is continually adjusted when the latest 'result' is known.
MMM clearly demonstrates that the first question any investor ought to ask when looking at an investment is not 'how much can I make' but 'how much could I lose'. The variable that has the greatest inpact on the opitmal percentage is not the % return you make when you win but the % losss you make when you lose. Preservation of capital is the key priority, once your shooting blanks your out of the game and there is no way you can win,
I hasten to add that I am not a licensened financial adviser. I will not recommend one investment over another on some non mathematical personal opinion basis. All I will give you is the mathematical information to aid in your decision making process.
