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The Kelly Criterion: You Don’t Know the Half of It | CFA Institute Enterprising Investor

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Despite expending substantial resources on a formal financial education, I did not encounter the Kelly criterion in business school or the CFA curriculum. I came across it almost by accident, in William Poundstone’s delightful book Fortune’s Formula. Created in 1956 by John Kelly, a Bell Labs scientist, the Kelly criterion is a formula for sizing bets or investments from which the investor expects a positive return. It is the only formula I’ve seen that comes with a mathematical proof explaining why it can deliver higher long-term returns than any alternative. In my view, the formula is consistent with the value investing concept of a margin of safety and leads to concentrated portfolios in which the dominant ideas have the greatest edge and smallest downside. Despite its relative obscurity and lack of mainstream academic support, the Kelly criterion has attracted some of the best-known investors on the planet, Warren Buffett, Charlie Munger, Mohnish Pabrai, and Bill Gross, among them.

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