Four Ideas from gambling on innovation with the Kelly Criterion.

The Kelly algorithm says that based on the probability (p) of success and the payback (b) of an investment, that there is an optimum fraction (f) of resources that you should invest. In short, Kelly tells you how to bet in the face of uncertainty. Here are a few heuristics from the Kelly Criterion (KC):

1. Don’t bet too much on one type of investment. The KC gives a precise value for how much to invest.

2. If the Kelly Criterion tells you that f < 0, don’t bet at all! It’s a losing bet in the long run!

3. If you anticipate that a great opportunity “might” come along, hold some in reserve, maybe 10-20%. That is, to maximize growth, don’t max out investing.

4. If you anticipate that learning will happen to increase your probability and/or payback, you should increase your investment.

Each of these statements might seem a bit obvious. The magic of the KC is that it gives “the numerical fraction” you should invest. Please feel free to contact me with questions. The KC is a mostly unknown gem in investing in innovation!