Investment method: Kelly's Optimal Growth Strategy equation
Every decision in life is a gamble. That's because you cannot predict the future nor any outcome resulting from your decisions or actions.If this is so, then how come some people always seem to make the best decisions?
Well, they do precisely the opposite of Han Solo, who said: "Never tell me the odds!"(This is probably why Captain Solo, although immensely talented, somehow owed a huge debt to Jabba the Hut!).
Successful people WANT to know the odds, and also want ANY information (hopefully impartial and hype-free) that will enable them to compute the odds of success of any project, decision, investment, etc.Unfortunately, most people think emotionally (which is an oxymoron!). They act or decide from fear or greed, not from rational analysis.
(If you're interested in learning more about rational analysis, I highly recommend any book written about Warren Buffett. The great thing is that not only will you make better investment decisions, but you can also use the same wisdom and analytical frameworks to make better decisions in life.)
Meanwhile, here's an interesting equation to contemplate: it's called the Kelly Optimal Growth Strategy equation.
Percentage of investment = 2P - 1where P is the probability of success.
Example: A friend of yours is an entrepreneur, and he asked you to consider investing in his business. You don't have a lot of money, so you want to think carefully about how much to invest.
Solution: First, carefully assess his business plan and figure out, with the help of financial advisors if necessary, the probability that he will succeed. Let's say it's 50%. Then:
Investment = 2(0.50) - 1 = 0
That is, you should NOT invest any money in the business.
But if the probability of success is 60%, then:
Investment = 2(0.60) - 1 = 0.20 or 20%
This means you should consider investing 20% of your money into his business (it's probably best to invest only half, or 10%, to ensure a margin of safety).
Well, they do precisely the opposite of Han Solo, who said: "Never tell me the odds!"(This is probably why Captain Solo, although immensely talented, somehow owed a huge debt to Jabba the Hut!).
Successful people WANT to know the odds, and also want ANY information (hopefully impartial and hype-free) that will enable them to compute the odds of success of any project, decision, investment, etc.Unfortunately, most people think emotionally (which is an oxymoron!). They act or decide from fear or greed, not from rational analysis.
(If you're interested in learning more about rational analysis, I highly recommend any book written about Warren Buffett. The great thing is that not only will you make better investment decisions, but you can also use the same wisdom and analytical frameworks to make better decisions in life.)
Meanwhile, here's an interesting equation to contemplate: it's called the Kelly Optimal Growth Strategy equation.
Percentage of investment = 2P - 1where P is the probability of success.
Example: A friend of yours is an entrepreneur, and he asked you to consider investing in his business. You don't have a lot of money, so you want to think carefully about how much to invest.
Solution: First, carefully assess his business plan and figure out, with the help of financial advisors if necessary, the probability that he will succeed. Let's say it's 50%. Then:
Investment = 2(0.50) - 1 = 0
That is, you should NOT invest any money in the business.
But if the probability of success is 60%, then:
Investment = 2(0.60) - 1 = 0.20 or 20%
This means you should consider investing 20% of your money into his business (it's probably best to invest only half, or 10%, to ensure a margin of safety).
posted by Super Peter at 10:53 PM
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