Going for Growth

This post is really for those who have an extended runway for investing and have a job and income that covers their expenses and leaves some left over for investing.

One of the tenets of investing is diversification. Don’t put all your eggs in one basket because if that goes wrong then you lose a lot of money. Strangely, investment professionals and those that recommend buy and hold don’t mind losing the odd 50% even when the portfolio is “diversified”.

We often discuss the Kelly Criterion as a way to invest for long term growth. But what many don’t realise is the Kelly formula is also the quickest way to reach your investment goals whatever they be.

Kelly suggests you should raise your allocation when the odds are in your favour. Diversification be damned!

This has been shown to be the optimal approach to investing, but many investment professionals don’t use Kelly because they are trained on the efficient market theory which recommends diversification because apparently investors don’t like volatility and so they choose safety over returns.

We prefer the Kelly approach (as does warren Buffett).

One approach is what is referred to as a half Kelly. Because the volatility of the portfolio can be high, Kelly experts came up with the idea of a half Kelly. That is, when the formula says to invest say, 80% of your total funds, a half Kelly means investing 40%. You simply half the amount. This way you reduce risk but interestingly you get around 75% of the original expected outcome. So in essence you get more bang for your buck.

The other is hedging which allows us to have a higher exposure to the long side (the market rises) and a small amount on the short side (when the markets falls). This way we can adjust the balance between our long and short portfolio given the circumstances.

If you are young you should use the Kelly Criterion as your method rather than the efficient market theory which doesn’t maximise your returns.

There is plenty of information about the Kelly Criterion on the web, but if you want to use it in your portfolio with some guidance, you know where to find us.