Part of my Knowledge Base.


Premise

The Kelly Criterion 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).

Source: Kelly Bet on Everything

Key Takeaway(s)

Highlights

  • Log scales apply to the difficulty and value you get for most things. Life satisfaction grows with log(money).
  • 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.
  • 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.

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. To make 20% more money with a 20% nicer boyfriend and 1.2 Twitter followers.

Source: Kelly Bet on Everything

Practical

  • The idea of a Kelly bet ties in pretty well with that of ‘optionality’ in Nassim Taleb’s Antifragile. I will be looking for low-downside, high-upside bets which use my comparative informational or slack-based advantage as leverage.
    • An example is cryptocurrency—worst-case scenarios see my balance drop to zero but best case is an order-of-magnitude increase in wealth as digital currency increases as a proportion of global GDP;
    • Another is the creation of a second revenue stream using slack generated through my full-time career. This is not so clear-cut but I need to be ready to execute on an opportunity when it appears I have a unique competitive or first-mover advantage.

Resources

Related