Comments on: Diversification as a long term investment strategy

By: evt

evt — Wed, 17 Mar 2010 23:51:51 +0000

It certainly is. It has been used by gamblers to manage there bankroll for ages, but astoundingly has had very little pickup in the investment community, even though E Thorp wrote a book on the topic in the late 60s (called “Beat the Market”).

It is important to note, most gamblers (or investors for that matter) should probably shy away from Kelly betting straight up, as though it does maximize growth, this may not be the goal of every investor (for example, a retired person simply needed to keep up with inflation).

By: Presh Talwalkar

Presh Talwalkar — Wed, 17 Mar 2010 23:42:41 +0000

evt: Yes, these calculations are simple compound interest and do not account for risk, though they are suggestive that an investment with such a risk profile would outperform a safer fixed one.

I will write about the Kelly Criterion–thanks for bringing it to my attention. It is fascinating mathematically.

By: evt

evt — Wed, 17 Mar 2010 23:25:05 +0000

Thanks for the response Presh. However, how do the calculations which you graphed take into account the risk and volatility? I assume that they were simply calculated as a fixed percentage, which does not take into account the greater risk. It seems by the method used to calculate here (if it was simple compounding interest) would suggest that we would be best to take an investment of 15% regardless of risk, as risk is not taken into account.

The Kelly Criterion gives an angle on the risk one should expose their bankroll too, given the expected payoff and volatility, and may shed some light in this area.

By: Presh Talwalkar

Presh Talwalkar — Wed, 17 Mar 2010 23:18:50 +0000

evt: Remember these figures are all expected returns, and higher returning investments typically entail higher risks. So it’s not as simple as putting all your money in the highest returning investment.

The point of diversification is to spread the risk by investing in several assets that together provide stability and returns. Investment B is meant to show the long-term gains to this strategy. In practice, both of the investments would exhibit large swings and returns are only expected.

By: evt

evt — Wed, 17 Mar 2010 23:07:34 +0000

I am at a loss to understand this. If if you know of an investment that earns 15% annually, why not just put 100% in that? It would outperform both A and B, without any diversification.