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Wealth, Risk, and Time: The Hidden Power of Math in Smart Investing

Updated: Mar 27


Just like you don’t need to be an auto mechanic to drive a car well, you don’t need to be a mathematician to build personal wealth. But a little mathematical intuition goes a long way.

In this article, we’ll explore two powerful, convexity-based principles that shape long-term investment success:

  1. Theoretical Convexity – how compound interest works over time, using math to magnify small, consistent gains into significant long-term growth.

  2. Applied Convexity – how smart investors use volatility, diversification, and convex portfolio construction to limit downside risk and amplify upside opportunity.

These concepts are connected by a foundational idea from mathematics called Jensen’s Inequality, which explains why averages don’t always tell the full story. In finance, convexity means that the path to a result can matter more than the average return itself—especially when time, volatility, and compounding are at play.


In plain terms: convexity is what makes compound interest magical, and portfolio convexity is what makes risk manageable. Mastering these ideas allows you to harness volatility, stay in the game, and let time work in your favor.


Let’s unpack both ideas—starting with the intuitive math behind compounding, and then diving into how convexity transforms risk into reward through smart portfolio design.


About the author:  Jeff Hulett leads Personal Finance Reimagined (PFR), a decision-making and financial education platform dedicated to empowering individuals and businesses. PFR offers specialized services for entrepreneurs, including fractional CFO support and comprehensive business startup services, helping visionaries turn ideas into thriving ventures. Jeff also teaches personal finance at James Madison University and delivers impactful seminars on financial literacy. Check out his book—Making Choices, Making Money: Your Guide to Making Confident Financial Decisions.


Jeff is a career banker, data scientist, behavioral economist, and choice architect. He has held leadership roles at Wells Fargo, Citibank, KPMG, and IBM, bringing decades of experience to his mission of transforming financial decision-making.


Jensen's Inequality was first developed over one hundred years ago by Danish mathematician Johan Jensen. Its intuition is foundational to Personal Finance.


Here is the elegant mathematical version of Jensen's Inequality:


E[g(x)] >= g[E(x)]

iff g is CONVEX

------------------

g(x) is the transforming function

x is the set of inputs to g(x)

"Iff" means "If and only if."

"E[...]" means the "Expected value of..."


Another way to say Jensen's Inequality:


"For a convex function, the expected value of the function is always greater than or equal to the sum of the expected value of the individual parts of that function."


- or -


"The sum of the whole is worth more than the sum of its parts"


Thus, for a convex function, the value of what you get out of something is always greater than what you put into it. Thus, Jensen demonstrates the basis for how wealth is created and the foundation for personal finance success!


Intuition to implement Jensen's Inequality

  • x or any other independent variables represents the baseline state. In the case of personal finance, the baseline is often time and your savings.

  • g(x) is the transforming function creating the new, future state. In the case of personal finance, the transformation will include a compounding interest rate. The personal finance function for transforming savings into future value will be discussed below.

  • The vertical axis (y) measures the Expected Value in the future state.

  • The horizontal axis (x) measures the drivers of that future state.

  • g(x), the transforming function, is convex to the drivers. For your savings, this means the expected value will grow at an increasing rate over time.

  • Convex functions are regenerative. It is good to seek convex systems to help transform your life. Exposing your savings to the convex compounding interest rate builds upon itself.

  • Positive Time and Value Space: In personal finance, convexity operates in positive time and value space, meaning both time and returns move forward and build upon themselves. This assumption reflects the natural growth trajectory of well-invested assets. **


You can test convexity by drawing (or imagine drawing) all the tangent lines along the surface of g(x). If the set of all tangents falls on or BELOW g(x), then it is convex. Conversely, if the tangent lines are all on or ABOVE g(x), then the function is concave.

Simulation Example


For this example, a simple simulation model was developed to help explain Jensen's Inequality.


Imagine a fair die, with an equal probability of rolling a 1 to 6. Further, imagine a system providing a payoff that is the square of the die. Thus the system transforms the base state die into future payoffs different than the baseline. In this example, we use a squaring transformation function - x^2. The squaring function of the die system is CONVEX. Because the function is convex, Jensen's Inequality suggests the expected payout of the die system is always greater than or equal to that expected from the die alone. Next, shown is the math for this example:

Mean X = 3.5

This is known as an Arithmetic Mean


"The sum of the parts"

Expected payoff from x = 12.25

The expected payoff from g(E[X]), referred to as 'the sum of the parts,' is calculated by first finding the arithmetic mean of X and then applying the transformation function to the mean.


"The sum of the whole"

Expected payoff from x^2 = 15.16667

The expected payoff from E[g(X)], referred to as 'the sum of the whole,' is calculated as the arithmetic mean of the transformed values X^2.


Thus, per Jensen's Inequality:

15.2 > 12.25 and E[g(x)] >= g[E(x)]


This demonstrates Jensen's Inequality, which states that for a convex function g(x), the expected value of the transformation E[g(X)] is greater than or equal to the transformation of the expected value g(E[X].


The expected value of the transformed convex function (CF) is always higher than the linear function (LF) from which it was transformed.


Please note: It is helpful to use simulations and visualizations to understand time-based transformation functions, such as those found in personal finance. There is efficiency and elegance in using personal finance math like Future Value or Annuity formulas. Certainly, mathematicians and financial engineers are taught to use formula-driven math in their work. However, the power of compounding and the subtle differences between arithmetic and geometric means are easy to lose without simulation and visualization. Fractal geometry, the mathematics of dynamical systems, is another example of where simulation and visualization are essential practitioner tools.


Jensen's Inequality is foundational for Personal Finance


Next, we answer the "So What?!" question. How does this help us in our day-to-day life? The time value of money is an on-point example describing the power of Jensen's Inequality. Our regular savings is the baseline state. To get the most from the baseline state, it is necessary to make our savings a consistent, repeatable habit. Consistent savings alone, without any investment return, is a linear (not convex) function. Once savings are habituated, we wish to transform them into wealth. The transformation occurs via investments leveraging the time value of money. It is regenerative. It builds upon itself to help consistent savings grow. Compounding is the transforming function that moves linear savings to CONVEX wealth building. The essential driver is time. Your savings will grow over time if it is properly invested.

For more information on a proper investment approach, please see the article:


As an example, let's say you can consistently set aside $150 a month. This money is invested in a diversified securities portfolio that earns 10% a year over the long run. The idea is to save for your retirement. In this example, you wish to retire at age 62. The second-order questions are: "When should I start saving?" and "What is the impact of delaying savings?


The good news is that If you start at 22 and save 40 years until retirement, you will earn over $1.25mm for retirement.


But convexity is a double-edged sword.


Because the transformation function is convex to time, delay works against you in a big way. Just delaying 8 years, from 22 to 30, causes a significant decrease in potential retirement value. In this example, an 8-year delay causes you to lose almost $700k for retirement. As shown in the inset graphic, an 8-year delay from 22 to 30 years old causes you to lose over half your potential retirement savings. Observe how the blue line begins at 100% of the 22-year-old's $1.25 million potential retirement value. As savings are delayed, the blue line drops to less than 50% of the potential retirement value at 30 years old.

The moral of the story is.... invest early and often! Even small amounts of savings will grow multiples over a longer time frame.


Please note: Elements of the time value of money are randomly determined. (aka "stochastic") For example, the 10% return discussed earlier is the expected average over time in the future. It is our best estimate based on past experience. It may be higher or lower in some years, depending on the economy and the investment markets. In general, for those saving for retirement, investing in well diversified, but higher volatility investment pools (like exchange-traded funds or ETFs) is suggested. This retirement investment strategy is discussed in the article:



It may be a bit uncomfortable that your investments are volatile. That is the price we pay for achieving a higher average return. In a longer timeframe like retirement, diversification protects your volatility from ruin. The nuances of risk and ruin are discussed in the article:



But what if you are already older than 22? Does this mean all is lost and you should not bother saving?


NO! Of course not! You will still benefit from the convex nature of the time value of money. Compare yourself to your older self. You will always do better by saving today instead of waiting until later.


Think like an economist! The past is sunk - the future is your playing field.


Connecting the dots - a personal finance transformation


Earlier we demonstrated the transformative power of convex functions and Jensen's Inequality. We showed this with a simple convex exponential function - x^2.


The time value of money is very similar. Next is the math notation for a common compounding interest function called FUTURE VALUE.

This is where:

FV - Future Value of your investment at the end of the time period.

PV - Present Value of your savings at the beginning of the time period.

r - interest rate

n - number of years or time periods


Notice this formula resembles our previous x^2 function. The essential similarity is the exponential nature of time, n. The future value function is also convex! This future value formula underlies the earlier graphic. This is how $150 of monthly savings is transformed to make you a millionaire by the time you retire.


Showing graphically how convex functions operate over time is essential to conveying the power of convexity to transform savings - and your life. While the future value "end number" is more compact and possibly more mathematically elegant, it is the visual that shows how time and savings transform your life.


But just showing why being convex to time is important is necessary but not sufficient for most people. A challenge to personal finance is our evolutionarily formed cognitive biases. While these cognitive biases were helpful heuristics keeping us alive millennia ago, today, they often make saving feel unnatural. The relevant cognitive bias to personal finance is availability bias. This is the bias keeping us focused on what is "available" today and heavily discounts that which is less "available" in the future. Unfortunately, long-term wealth is much less available than spending that savings on today's wants. We will discuss commitment devices as a tool to help manage the behaviors that we know are important but are difficult to do.


Please see this article for a personal finance example of Jensen's Equality in action!


Convexity and volatility


So far, we have shown the theoretical math as if life and investing returns on average. Of course, life is messy. Markets rise and fall. But what if volatility—the very thing that makes most investors anxious—could actually be your long-term ally?


That’s the practical power of convexity in smart investing.


Convexity doesn’t promise daily or yearly gains. Rather, it suggests that within a well-diversified portfolio, the mathematical shape of your return function favors you. When returns are modeled with a convex function, downside fluctuations hurt less than upside movements help. This is especially powerful over time—allowing volatility to become fuel for wealth creation.


Let’s frame this mathematically.


If wealth at time t is a function of stochastic returns:

and the function:


representing wealth is convex, then by Jensen’s Inequality, we know:

Where:







This tells us that convex functions benefit from variability—volatility increases expected value.


Understanding Volatility and Standard Deviation


In investing, volatility is typically captured by standard deviation, noted as σ. It measures how much returns deviate from their mean. When σ\sigmaσ is higher, it reflects more variability—greater swings both upward and downward.


Now here’s the key: if your wealth is modeled as an exponential function over time, such as:


Where:







This equation shows that volatility σ actually adds value to your expected long-term wealth due to the convexity of g. When your wealth function is convex, variance isn’t just risk—it’s return fuel.


Why Normality Assumptions Matter


These benefits assume that return distributions are approximately normal over time. Normality means:

  • Symmetry (returns are equally likely to be above or below the mean),

  • Predictable variance,

  • And an absence of extreme outliers (fat tails).


However, in short time frames, return distributions are often non-normal. They may have:

  • Skewness: asymmetric returns (e.g. long negative tails), and

  • Kurtosis: extreme outcomes are more likely than predicted by normal models.


In these cases, short-term volatility may increase ruin risk rather than return. That’s why time and diversification are essential.


Over a full business cycle (typically 7+ years), the Central Limit Theorem and diversification smooth out returns. They reduce skew and kurtosis, allowing the long-term behavior of the portfolio to approach normality. This reactivates the full power of Jensen’s Inequality and positive convexity.


Investing Intuition


Put simply: being convex to time means staying invested and diversified long enough to let math work in your favor. Even if some assets underperform or fail, diversification reduces the risk of total loss, while volatility adds to long-term gains through compounding.

So:

  • Diversification prevents ruin, even in chaotic times.

  • Convexity makes volatility valuable, not just tolerable.

  • Time transforms randomness into reliability.


Letting volatility work for you—not against you—is the foundation of long-term investing success.


The great financial crisis of 2007-2008 is an example of significant downside volatility risk. What if you had lost 40% of your wealth in 45 days? Would you have been able to stay in the game?

I hope so.


Next is an example of the benefits of being convex to time. it shows how downside volatility risk was overcome by the upside volatility benefit, EVEN AFTER THE GREATEST FINANCIAL CRISIS SINCE THE GREAT DEPRESSION. In a convex system, losses are naturally capped at zero and losing investments are naturally de-emphasized or replaced by winning investments. But the upside remains uncapped, allowing long-term investors to recover and thrive even after severe downturns. Another way to look at it -- do NOT think of volatility risk as being good or bad. Volatility risk WILL happen in any well-functioning market. The crux move is being CONVEX TO TIME to properly manage a well-diversified portfolio. The challenge, then, is how to stay in the game, even when the market is cratering. This is the domain of commitment devices, like auto transfer, to make sure your investment strategy is operating in a market down drafts. As Nobel laureate and University of Chicago behavioral economist Richard Thaler said:


"There is growing evidence that most people would be better off not paying attention to the ebbs and flows of the stock market.”


This graphic shows that though the paper losses in late 2008 were 40%, investors that stayed invested and stayed convex to time, would have gains almost QUADRUPLE in the next decade. This is the power of convexity and having a long-term perspective.


For more information, please see the article:


Please note: This is an example of how to:

  1. Take a single non-ergodic "time is NOT your friend" company and

  2. Use diversification to have it behave more like an ergodic "time IS your friend" portfolio.


Endnote: ** Technically, a circle is a convex shape, and in theory, a convex function could exist in negative time or bend back on itself, implying movement backward in time. Additionally, a convex function, in theory, could exist in negative expected value (EV) space. However, for practical purposes in personal finance, we make three key assumptions:

  1. Time travel is not possible, so reversing time or negative time is not relevant.

  2. In a well-diversified, unleveraged portfolio, reaching a negative EV is not a realistic outcome.

  3. The bottom of the convex function starts at the origin where time and EV are both 0.


Therefore, from a practical standpoint, being convex to time implies a function that increases at an increasing rate, using the portion of the convex function that is relevant to financial growth and wealth accumulation. Below, shows several convex, circular functions. The green part is the only segment meeting the special properties of being convex to time for wealth building.



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