Money management is the process of managing money. It includes investment, budgeting, banking and taxes. It is also called investment management.
Money management is a strategic technique employed at making money yield the highest of interest-yielding value for any amount of it spent. Spending money to provide answers to all cravings (regardless of whether they are justifiable or not to be included in budget basket) is a natural human phenomenon. The idea of money management techniques is developed to plummet the amount individual, firm and institutions spends on items that add no significant value to its living standard, long-term portfolios and asset-basins. Warren Buffet, in one of his documentaries, admonished prospective investors to embrace his highly-esteemed "frugality" ideology. This is the basis of every sound money management formulas. The following are powerful techniques that can be employed in making every expense made to be worth it:
1. cutting your budget on social needs
2. avoid any snob-appealing expense
3. always go for the most cost-effective alternative (establishing small quality-variance bench-mark, if any)
4. increase expenses more on interest bearing item than any other thing
5. establish the expected benefits of every desired expense using the canon of plus/minus/nil to standard of living value system.
These techniques are investment-boosting and portfolio-multiplying.
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 personal and business perspective. Greater money management can be achieved by establishing budgets and analysing 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 winning or losing trading system, such as %Loss probability > %Win probability).