Photo by conorwithonen

This post is related to the last one regarding probabilities and payoff and how we should bet.

We often hear about people betting their life savings of \$100k on the next property of say \$500k, hoping for that 20% rise before TOP and make \$100k return (with a capital base of \$100k). Lets see how this works in that matrix thingy we used in the previous post:

Let’s give the benefit of doubt and say this guy has 70% chance of making \$100k, he has read the property market well, the cycle is turning, the stars are aligned. However, again in life, since nothing is 100% one, we have to think that he also has a 30% downside whereby he will lose \$250k (ppty of \$500k goes down by \$100k, mortgage \$130k, legal fees \$20k all add up to \$250k)

Probability payoff
0.3 -250k -75k
0.7 100k 70k
Expected return -5k

Now we see that the expected return is negative. Even if we tweak the no.s here and there, which I did, the expected return is not high. You can probably get to expected return of \$80k – which is good if you use \$100k as the base. But in reality the base is \$500k, bcos the guy borrowed \$400k from the bank. So you risked a life of perpetual debt for \$80k, is it worth it? Read more…