Thursday, January 29, 2015

Focus or Diversify?

Crosshair
Life is a series of resource allocation decisions.  Whether in business or personal decisions, we are continually deciding where to focus our time, attention and money so we are most likely to enjoy the best results.

The physicist and game theorist John L. Kelly developed a mathematical formula in 1956 that can be used to guide those decisions.

f = p(b+1)-1
      b

In the Kelly criterion, f represents that fraction of resources that should be allocated to a particular endeavor. The probability of achieving the expected results within the established time period is represented by p. b is the odds or win/loss ratio on the investment.

John L. Kelly Jr.
John L. Kelly Jr.
Application of the Kelly criterion indicates that endeavors where we believe the probability of success is the highest are the places where we should invest the most resources. Determining the probability of success is a judgement call, but one that can be improved greatly by research and knowledge about the particular opportunity.

In general, diversification is a compensation for poor research and indecisiveness.  The highest returns come from a greater focus on fewer things, but the right things.

How are you spending your time, attention and money?

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