Money management is the process of expense tracking, investing, budgeting, banking and evaluating taxes of one’s money which is also called investment management.
Money management is a strategic technique to make money yield the highest interest-output value for any amount spent. Spending money to satisfy cravings (regardless of whether they can justifiably be included in a budget) is a natural human phenomenon. The idea of money management techniques has been developed to reduce the amount that individuals, firms, and institutions spend on items that add no significant value to their living standards, long-term portfolios, and assets. Warren Buffett, in one of his documentaries, admonished prospective investors to embrace his highly esteemed “frugality” ideology. This involves making every financial transaction worth the expense:
- avoid any expense that appeals to vanity or snobbery
2. always go for the most cost-effective alternative (establishing small quality-variance benchmarks, if any)
3. favor expenditures on interest-bearing items over all others
4. establish the expected benefits of every desired expenditure using the canon of plus/minus/nil to the standard of living value system.
These techniques are investment-boosting and portfolio-multiplying. There are certain companies as well that offer services, provide counseling and different models for managing money. These are designed to manage grace assets and make them grow.
Trading and investment
Money management is used in investment management and deals with the question of how much risk a decision maker should take in situations where uncertainty is present. More precisely what percentage or what part of the decision maker’s wealth should be put into risk in order to maximize the decision maker’s utility function.
Money management gives practical advice among others for gambling and for stock trading as well.
Money management can mean gaining greater control over outgoings and incomings, both in a personal and business perspective. Greater money management can be achieved by establishing budgets and analyzing costs and income etc.
In stock and futures trading, money management plays an important role in every success of a trading system. This is closely related with trading expectancy:
“Expectancy” which is the average amount you can expect to win or lose per dollar at risk. Mathematically:
Expectancy = (Trading system Winning probability * Average Win) – (Trading system losing probability * Average Loss)
So for example even if a trading system has 60% losing probability and only 40% winning of all trades, using money management a trader can set his average win substantially higher compared to his average loss in order to produce a profitable trading system. If he set his average win at around $400 per trade (this can be done using proper exit strategy) and managing/limiting the losses to around $100 per trade; the expectancy is around:
Expectancy = (Trading system Winning probability * Average Win) – (Trading system losing probability * Average Loss) Expectancy = (0.4 x 400) – (0.6 x 100)=$160 – $60 = $100 net average profit per trade (of course commissions are not included in the computations).
Therefore the key to successful money management is maximizing every winning trades and minimizing losses (regardless whether you have a winning or losing trading system, such as %Loss probability > %Win probability).
Ethical or religious principles may be used to determine or guide the way in which money is invested. Christians tend to follow the Biblical scripture. Several religions follow Mosaic law which proscribed the charging of interest. The Quakers forbade involvement in the slave trade and so started the concept of ethical investment.
- ^Asset and Money Management Archived 2015-07-11 at the Wayback Machine Retrieved 5-08-2015. (in Swedish)
- ^ Jump up to:ab Harris, Michael (May 2002). “Facing the facts of risk and money management” (PDF). Trading Strategies. Active trader. p. 33. Archived from the original (PDF) on 2006-10-17. Retrieved 2006-11-19.
- ^Gomez, Steve; Lindloff, Andy (2011). Change is the only Constant. IN: Lindzon, Howard; Pearlman, Philip; Ivanhoff, Ivaylo. The StockTwits Edge: 40 Actionable Trade Set-Ups from Real Market Pros. Wiley Trading. ISBN 978-1118029053.
Ofer Abarbanel is a 25 year securities lending broker and expert who has advised many Israeli regulators, among them the Israel Tax Authority, with respect to stock loans, repurchase agreements and credit derivatives. Founder of TBIL.co STATX Fund.