Part of my Knowledge Repository.
- One of the most useful concepts related to making bets is the Kelly criterion.
- It states that when facing a series of profitable bets, your wagers should grow proportionally with your bankroll and with your edge on each bet. Specifically, that you should bet a percentage of your bankroll equivalent to your expected edge — if a bet has a 55% chance to go your way your edge is 55%-45%=10% and you should risk 10% of your bankroll on it (assuming equal amounts wagered and won).
- People’s intuition is usually that Kelly bets are too aggressive, that betting half of everything you have a on 75%-25% bet is too wild. But the Kelly criterion is actually quite conservative in that it maximizes not the expected size of your bankroll but it’s expected logarithm.
- If you have $1,000 and you’d risk no more than $750 for an equal chance to win $3,000, you’re logarithmic in dollars and should “bet the Kelly”.
- Log scales apply to the difficulty and value you get for most things. Life satisfaction grows with log(money).
- Making a new friend is probably one tenth as valuable to someone who has 10 friends than to someone who has one, so your social life depends on log(friends). It’s equally hard to double one’s number of blog readers, sexual partners, job offers etc regardless of how many you have, as opposed to incrementing each by a fixed amount. It’s equally valuable too.
- So, for most things, it makes sense to bet the Kelly. You’ll need to find out what bets are available, where your edge is, and what your bankroll is.
- What kind of Kelly bets can you make with money? Investments are the obvious one, and standard investment advice is to switch to high-risk-high-return assets when you have some money to spare.
- You can also make bets on your ability to make money: take on a side project, look for a new job, start your own business, ask for a raise. Each one entails a risk and a possible reward. Your bankroll is your literal bankroll, your edge is your ability to make money for yourself or your employer.
- When your friendships are few and tenuous, people’s inclination is to play it safe and conform to the crowd. It won’t make you a social star, but it won’t turn people away either. But if you have an edge in popularity and enough close friends to fall back on you can make some bets on your own vision.
- Whatever creative outlet you have, you get better by getting feedback from the audience. This is a gamble — if people don’t like what you’re making you won’t get their attention next time.
- A lot of people are seeing the rise in callout and cancel culture purely as a threat, a reason to go anonymous, lock their accounts, hide in the dark forest of private channels. But where there’s threat there’s also opportunity, and where reputations can be lost they can also be made.
- Having children is a bet that you have enough of an edge on life that you can take care of another human and still do well. The payoff is equally life-changing.
I wrote this post because of my endless frustration with my friends who have the most slack in life also being the most risk averse. They have plenty of savings but stay in soul-sucking jobs for years. They complain about the monotony of social life but refuse to instigate a change. They don’t travel, don’t do drugs, don’t pick fights, don’t flirt, don’t express themselves. They don’t want to think about kids because their lives are just so comfortable and why would you mess with that?
They often credit their modest success to their risk-aversion, when it’s entirely due to them being two standard deviations smarter than everyone they grew up with. By refusing to bet on themselves they’re consigned forever to do 20% better than the most average of their peers.
How I’m applying this
The last paragraph resonated with me—I have a large amount of slack but still feel very risk-adverse. I will be looking to invest more aggressively in cryptocurrency and Kelly bet on myself more. This includes looking to acquire a secondary revenue stream as I continue to save for a property hedge career volatility.