This is why capital growth theory rules

Aug 25, 2019

If you’re aiming to maximise your long-term wealth, the Kelly capital growth criterion can help you towards the highest expected result.

From blackjack players to sports betting variations on the same model have been used for at least half a century, aiming to place high value bets on favourable scenarios.

You can use a similar approach to investing, but in practice there are a range of issues you need to take into account – the probability of loss, your tolerance for risk, unexpected scenarios or Black Swan events – so people may tend to opt for a more conservative approach.

Kelly model simulations show that the potential for wealth creation is enormous, but investors need to protect themselves from adverse outcomes or loss by spreading their capital across a range of independent investments.

Simulations show that where significant leverage is used the potential for a very poor outcome is greater.

Overall, with careful risk management, the Kelly model can lead to impressive gains, and the Kelly criterion is often associated with focused investors such as Warren Buffett, Charlie Munger, Bill Gross, and others.

I discussed this in the short video here

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