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Is your investment better than a coin toss?

Ever needed a quick way to assess a potential investment your business is considering?

There are literally dozens of methods out there, but one I keep coming back to has the advantage of boiling everything down to one number, which you can compare to something easy to envisage: the toss of a coin.

Here's what you need:-

  1. what's the potential upside if things go well?  (Call this U)
  2. what's the potential downside if it doesn't? (Call this D)
  3. what's the chance of success? (Call this C)

The magic number =

(U/D) * C

A flip of the coin would be 1.  A bookie delivers about 0.95, a fruit machine about 0.9. The national lottery more like 0.1

How does your investment line up? 

'Phil

By the way, for the spread-betters out there amongst you, you could use this for personal gains too. For example, if a company might or might not be on the cusp of discovering a decent sized oil field, U would represent the increased share price if the result goes well, and D the downside of your stop loss being hit it all goes to pot. Hard to get to the 'C' figure perhaps, but with some scenario planning, you should be able to get a feel for the sensitivity of the investment. If most of your scenarios deliver four of five times the result of the coin toss, it may be worth a punt.


Published: 19-05-14 by Phil Baxter

investment