What is the Kelly Criterion in investing?

It's a math formula that calculates the optimal percentage of your capital to put into a single investment, based on its expected edge and payout odds. Created by John Kelly Jr. at Bell Labs in 1956, it aims to help investors grow their capital over time while avoiding the kind of oversized bet that can wipe out a portfolio.

How do you actually calculate the Kelly Criterion?

The formula is edge divided by odds, which gives you the optimal fraction of capital to invest. In a coin-flip example where you win $2 on heads and lose $1 on tails at 50/50 odds, the edge works out to $0.50, and dividing that by the $2 payout gives 25%. That's the portion of your bankroll the formula says to risk.

What is the Half-Kelly strategy, and why do investors use it?

Half-Kelly means investing exactly half of what the Kelly formula recommends. Since your edge is always an estimate and estimates are rarely perfect, this approach cuts portfolio volatility while still keeping the discipline of sizing positions by conviction. If Kelly suggests 20% of capital, Half-Kelly puts in 10%, and Quarter-Kelly would be just 5%.

How can financial advisors use the Kelly Criterion with clients?

Advisors don't need to calculate an exact Kelly percentage. Instead, it works as a mental framework for risk budgeting, helping avoid oversized concentrated bets while also flagging when a portfolio is spread so thin across tiny positions that it dilutes returns. It also gives advisors a rational anchor to keep clients invested when fear or greed pushes them toward emotional decisions.

Why does position sizing matter more than being right about an investment?

Many investing failures don't come from a bad thesis. They come from sizing a position too large, so that even a correct idea can't survive a rough patch. Compounding only works if you stay in the game long enough to let it play out, which is why survival matters more than any single prediction.

Kelly Criterion Explained: A Practical Guide to Position Sizing

Get in Touch

Kelly Criterion Explained: A Practical Guide to Position Sizing | Dunham