Expected Value Formula: The Missing Key To Building Wealth (2024)

FAQs

What is the wealth building equation? ›

Most people understand one element of building wealth, but not the other. It looks like this: Wealth = Income + Investments – Lifestyle.

By calculating expected values, investors can choose the scenario most likely to produce the outcome they seek. In statistics and probability analysis, the expected value is calculated by multiplying each of the possible outcomes by the likelihood that each outcome will occur and then summing all of those values.

Overall, the rule of thumb is to judge by your salary. Typically, by the time you enter retirement you want to have 10 times your annual salary saved up in your retirement fund. One common benchmark is to have two times your annual salary in net worth by age 35.

Expected Value (EV) is a forecasted value of an investment. It is calculated by multiplying the possible outcomes by the probability of their occurrence and then adding all those values. EV is the long-run average of random variables. Also, it is the probability-weighted average of all possible values.

When our team completed The National Study of Millionaires, we found that 93% of millionaires said they stick to the budgets they create. Ninety-three percent! Getting on a budget is the foundation of any wealth-building plan.

The expected return is calculated by multiplying the weight of each asset by its expected return. Then add the values for each investment to get the total expected return for your portfolio. Hence, the formula: Expected Portfolio Return = (Asset 1 Weight x Expected Return) + (Asset 2 Weight x Expected Return)...

The Expected Value (EV) shows the weighted average of a given choice; to calculate this multiply the probability of each given outcome by its expected value and add them together eg EV Launch new product = [0.4 x 30] + [0.6 x -8] = 12 - 4.8 = £7.2m.

While having a net worth of about $2.2 million is seen as the benchmark for being rich in America, it's essential to remember that wealth is a subjective concept. Healthy financial habits and personal perspectives on money are crucial in defining and achieving wealth.

Your annual household pretax income multiplied by your age, then divided by 10, equals "what your net worth should be," according to Stanley and Danko. The numbers in the middle-age ranges might look feasible, but the formula is less likely to work for people just starting out in life.

When would you calculate an expected value? ›

Calculating expected values

Expected values are a tool in statistics that captures what the outcome will be “on average” when we can't predict something with certainty.

For example, when you roll a die, each outcome (1 through 6) has an equal 1/6 chance. Therefore, the expected value of rolling a die is 3.5.

To find expected value in Excel, first enter all of your data into a table. Then, enter the formula “=SUMPRODUCT(probability,outcome)” into a cell. This formula will take the probability of each outcome, multiply it by the outcome, and then sum all of the products, giving you the expected value.

After surveying people, the authors developed a formula or simple rule of thumb to determine if you're wealthy: Multiply your age times your realized pretax annual household income from all sources except inheritances. Divide by ten. This, less any inherited wealth, is what your net worth should be.

Stanley later expanded on this by calling it your "Wealth Equation" and defining an index called the "Wealth Index" (WX) which is simply your net worth divided by the expected wealth for your age and income.

It's an easy way to calculate just how long it's going to take for your money to double. Just take the number 72 and divide it by the interest rate you hope to earn. That number gives you the approximate number of years it will take for your investment to double.

Choose the right career

And one crucial detail to note: Millionaire status doesn't equal a sky-high salary. “Only 31% averaged $100,000 a year over the course of their career,” the study found, “and one-third never made six figures in any single working year of their career.”