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Kelly Criterion Avoid Ruin.html
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Kelly Criterion Avoid Ruin.html
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<p>![[Naval-Ep44 (1).mp3]]</p>
<p><strong>Nivi:</strong> Let’s chat about the Kelly criterion.</p>
<p>
<strong>Naval:</strong> The Kelly criterion is a popularized mathematical
formulation of a simple concept. The simple concept is: Don’t risk
everything. Stay out of jail. Don’t bet everything on one big gamble. Be
careful how much you bet each time, so you don’t lose the whole kitty.
</p>
<p>
If you’re a gambler, the Kelly criterion mathematically formulates how
much you should wager per hand, even if you have an edge—because even when
you have an edge, you can still lose. Let’s say you have 51-to-49 edge.
Every gambler knows not to bet the whole kitty on that 51-to-49
edge—because you could lose everything and won’t get to come back to the
average.
</p>
<p>
Nassim Taleb famously talks about
<a href="https://medium.com/incerto/the-logic-of-risk-taking-107bf41029d3"
>ergodicity</a
>, which is a fancy word for a simple concept: What is true for 100 people
on average isn’t the same as one person averaging that same thing 100
times.
</p>
<p>
<strong
>Ruining your reputation is the same as getting wiped to zero</strong
>
</p>
<p>
The easiest way to see that is with
<a href="https://en.wikipedia.org/wiki/Russian_roulette"
>Russian roulette</a
>. Say six people play Russian roulette one time each, and each winner
gets $1 billion. One person ends up dead and five people get $1 billion.
Compare that to one person playing Russian roulette six times with the
same gun. They are never going to end up a billionaire—they will be dead
and worth zero. So risk-taking—especially when the averages that are
calculated across large populations—is not always rational.
</p>
<p>
The Kelly criterion helps you avoid ruin. The number one way people get
ruined in modern business is not by betting too much; it’s by cutting
corners and doing unethical or downright illegal things. Ending up in an
orange jumpsuit in prison or ruining your reputation is the same as
getting wiped to zero—so never do those things.
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