Di-worse-ification

The key to balancing risk and return comes from a modern reading of a telecom scientist’s research. Here’s what to do.

“Pocket Aces” by DALL•E

Diversification divides investors. Some say you should spread your bets as wide as possible; others say you should only buy your best ideas. Who's right? On the one hand, concentration adds risk. On the other, diversification—or diworseification, as Warren Buffett calls it—cuts return. The optimal balance between the two lies on the Kelly ratio.

The Kelly method is a statistical technique used to determine the optimal size of an investment in your portfolio. Developed by scientist John Kelly, It tells you the percentage of your funds you should invest in an asset to maximise the long-run growth rate of your portfolio. The Kelly method outperforms all other portfolio management techniques. Modern Portfolio Theory (MPT), equal weighting, and minimum variance all fall short of Kelly.

It takes the expected return and covariance of returns of multiple assets and calculates the optimal portfolio. It will select a small group of high-return assets with little relationshi…