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Book Ideas For The Thoughtful Investor With William Poundstone

Conversation with the author of Fortune's Formula: The Untold Story of The Scientific Betting System That Beat The Casinos And Wall Street

Chris DeMuth Jr:

What has changed since you published your book? It seems to me that it has stood the test of the time thus far, but do you have any second thoughts? Anything that you would add if it were published today?

William Poundstone:

I think there has been much greater awareness of the fallibility of human intuition and expertise-the Nate Silver revolution, you might say. One reaction to the Kelly criterion has always been, "I don't need it; my intuition tells me how to size bets." I think more people are open to the idea that even experts need all the quantitative help they can get.

In 2011 Ed Thorp, William Ziemba, and Leonard MacLean edited a volume of all the important Kelly criterion papers (The Kelly Capital Growth Investment Criterion, World Scientific Publishing). I think that was an important event insofar as so many of early papers appeared in journals where those most interested wouldn't have seen them-a telecommunications engineering journal, in the case of Kelly's article. It's been hard to search for articles because authors used different terms (Kelly criterion, capital growth criterion, etc.)

Chris DeMuth Jr:

Are there any specific investments that you have made or would make today as a result of your ideas? What are you doing as a practitioner beyond thinking and writing?

William Poundstone:

I'm not really a practitioner so I don't have much an answer to this one. It has however influenced my thinking about asset allocations. Small investors are told that allocations should be determined by "risk tolerance," as if this is a fixed personality trait. But actually risk tolerance is contingent: everyone becomes a lot less risk tolerant after they've lost money! It's useful to know, first of all, that there is such a thing as too much risk, in that it decreases long-term capital growth. It's also useful to know that Kelly betting/investing is emotionally difficult for many people, and it's okay to dial down the risk. This isn't hugely costly: half-Kelly betting has 3/4 the return. Knowing a few mathematical facts can help clarify the emotional/visceral understanding of risk.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Additional disclosure: Chris DeMuth Jr is a portfolio manager at Rangeley Capital, a partnership that invests with a margin of safety by buying securities at deep discounts to their intrinsic value and unlocking that value through corporate events. In order to maximize total returns for our partners, we reserve the right to make investment decisions regarding any security without further notification except where such notification is required by law.