Abaci's Common Sense Investing

My new grown fondness of mathematicians.

I recently finished two books about math and mathematicians by William Poundstone. I don't know how to classify these books but I'd say it's not boring at all. It's like 'Freakonomics' in math and written in a more serious manner.

It covered topics like atomic bomb, world war strategy, game theory and moral dilemma, binary code, casinos, stock market, and private lives of mathematicians, the last bit which turned out to be most interesting and surprising.

One anecdote cited one math professor Edward Thorp was so much into thinking about winning the casino that he built a roulette predicting device with his colleague and tried it in Vegas, in disguise and with their wives trained too! (for the stunt required four person to pull off successfully)

His interest later transferred to blackjack and he wrote a paper on it, which got so much attention from outside the academic circle (for obvious reason) that the idea of card counting was later explained in the best seller "Beat the Dealer". As an experiment to prove his idea, he unknowingly teamed up with two big time gangsters from New York, who provided seed capital, and did a nation wide casino tour. He later found himself practically banned from all casinos. So he began studied the stock market and before long he co-founded a hedge fund which delivered a compound return of 15% over 19 years, only to be dissolved because his partner was associated with the then junk bond king Mike Milken and hence was under SEC investigation and later trial.

I sure wouldn't have guessed a mathematicians would lead a life like that. But the biggest discovery of the book was about another math professor John Kelly and his concept of the Kelly criterion, which became the cardinal rule in gambling but never appeared in modern day finance, just like the whole value investment school of thought by Graham and Dodd.

In mathematical term it means maximizing the geometric mean will maximize long term grow rate in a repeated gamble with a positive expected value. In my term it translates to "it's better be safe than sorry" in investment (or gamble). Being risk averse in making investments will generate the greatest long term wealth, whereas being risk neutral will lead to blow up in the long run in certainty. This is why it's common to witness strings of success followed by spectacular fallout in finance. BTW, the Graham and Dodd school of thought follows very a similar line of reasoning but without the mathematics, i.e. stress of capital preservation before appreciation.

I know this all sounds too philosophical but this has always been a mystery and dilemma to me, as my felt like playing safe but was taught to be risk neutral in making decisions. So thanks professor Kelly for providing the mathematical ground.