The Art of the Overbet

Pre­vi­ously: The Kelly Criterion

Last time I said, never go full Kelly.

In prac­tice, I strongly agree with this. Either one should go far over full Kelly be­cause the core Kelly as­sump­tions have broken down and you want to throw the rules out the win­dow, or you are try­ing to re­spons­ibly grow a bank­roll and full Kelly bet­ting on what you be­lieve your edge to be would be massively overly ag­gress­ive.

This time we go over the second cat­egory with prac­tical ex­amples. What are situ­ations in which one should en­gage in what ap­pears to be massive over bet­ting?

Four main scen­arios: Not win­ning is cata­strophic, los­ing is ac­cept­able, and los­ing is im­possible, los­ing is in­ev­it­able.

You Win or You Die

When you play the game of thrones, you win or you die. If play­ing it ‘safe’ with your re­sources means you don’t win, then it means that you die. Either don’t play, or don’t hold back.

In Rounders (spoiler alert, movie is re­com­men­ded), the star finds him­self ow­ing $15,000 to the Rus­sian mob, and his best ef­forts could only get him $10,000. Without bet­ter op­tions and un­will­ing to run for his life, he walks into the poker club of the man he owes the money to, and says “I owe you that money to­mor­row, right? I’ve got $10,000. I’m look­ing for a game.”

Fam­ously, early in the com­pany’s his­tory, the founder of UPS once found him­self without the funds to make payroll. He knew that if he missed payroll, that would be the end of UPS. So he flew to Ve­gas with what funds he had, bet them all on black, won, made payroll, and now we have a UPS.

Ma­gic play­ers of­ten se­lect ‘safe’ decks in­stead of ‘risky’ decks. This is ex­actly back­wards. If you flame out of a tour­na­ment and lose all rounds, you get noth­ing. If you win half of them, you still get noth­ing. If you win three quar­ters, you usu­ally still get al­most noth­ing re­l­at­ive to win­ning. Ex­tra vari­ance is great.

If you be­lieve that the fate of every­one de­pends on cross­ing a threshold or hit­ting an im­possibly pre­cise tar­get, no mat­ter how bad the odds, you de­ploy everything you have and take your best shot.

There’s a dead­line. We don’t have time for Kelly.

Win or Go Home

Los­ing not be­ing so bad, or con­tinu­ing to play not be­ing so good, is ef­fect­ively very sim­ilar to los­ing be­ing cata­strophic but not safely avoid­able. In both cases, sur­viv­ing is not a worth­while goal.

A clas­sic mis­take is the gam­bler who for­gets that they are us­ing their bank­roll to pay the rent. On for­ums I would of­ten read stor­ies of hard work­ing sports gam­blers with mid-five fig­ure bank­rolls. They make sure to make only ‘re­spons­ible’ wagers on sport­ing events, risk­ing only 1-3% of their funds each time. When they have a good month, they could eat and make rent, but that ate up most of the profits.

What they con­tinu­ously failed to real­ize was that this was not a sus­tain­able situ­ation. Be­ing ‘re­spons­ible’ only en­sured that, even if they were good enough at pick­ing win­ners, they would never suc­ceed due to their fixed costs. They were be­ing ‘re­spons­ible’ with their siz­ing re­l­at­ive to their bank­roll, but com­pletely ir­re­spons­ible when siz­ing re­l­at­ive to fixed costs of their time.

When I first star­ted gambling on sports, I put aside a fixed bank­roll I com­mit­ted not to re­plen­ish­ing, but then ac­ted what any Kelly-style for­mula would call com­pletely ir­re­spons­ible with that bank­roll un­til after my first few double ups. As the op­er­a­tion be­came clearly worth my time, I scaled back and did more ‘re­spons­ible’ siz­ing, know­ing that I wouldn’t be eaten alive by fixed costs.

Later, when ex­plor­ing if it was worth­while to re­turn to wager­ing, I did a sim­ilar thing, struggled, and even­tu­ally lost everything I’d set aside. This was very good. It let me move on. To this day, we can never know for sure whether I had an edge dur­ing that second at­tempt – I sus­pect my luck was quite per­verse – but I do know it wasn’t the best use of my time to find out.

Fail fast is a well-known prin­ciple for start-ups. I broke this rule once, with MetaMed, and it was an ex­pens­ive mis­take. Even if you have se­greg­ated your po­ten­tial losses in dol­lar space, you need to con­tain them in time space, and emo­tional space, and so­cial space.

There’s no dead­line. But we don’t have time for Kelly.

Bet You Can’t Lose

You can’t lose everything if you can’t risk everything.

Most people’s re­sources are mostly not money, or even things at all, most of the time. When someone ‘loses everything’ we talk of them los­ing their friends, their fam­ily, their repu­ta­tion, their health, their abil­ity to work. And for good reason.

There is a scene in De­fend­ing Your Life where we flash back to the main char­ac­ter pay­ing over $2,000, a third of all the money he has, to avoid a middle seat on an in­ter­na­tional flight. In con­text, this is to his credit, be­cause it was ‘brave’ to risk spend­ing so much. In a sense it was brave, in a more im­port­ant gen­eral sense it was stu­pid, but in the most im­port­ant sense he was spend­ing a very small frac­tion of his re­sources, so the rel­ev­ant ques­tions were: Was this trans­ac­tion worth it? No. Did this put the char­ac­ter at risk of hav­ing a li­quid­ity crisis where not hav­ing any cash could be ex­pens­ive? A little.

The best reason to do ‘safe’ things with money, and to main­tain li­quid sav­ings, is to avoid pay­ing the cost of need­ing li­quid­ity and not hav­ing it, or pay­ing the costs of avoid­ing scen­arios where that li­quid­ity might be­come ne­ces­sary. This in­cludes the abil­ity to take ad­vant­age of op­por­tun­ity. Avoid­ing ex­tra costs of hav­ing to bor­row money, which is ex­pens­ive in time and in emo­tional well-be­ing and so­cial cap­ital, not only in money, is by most people largely un­der­es­tim­ated. Slack is vi­tal.

There is also a be­ne­fit to hav­ing no cash. For some people, and in some fam­il­ies and cul­tures, one who has cash is ex­pec­ted to spend it, or in­ev­it­ably will quickly spend it. So­me­times this is on one’s self, some­times on oth­ers, but the idea that one can have money and con­serve it by spend­ing only re­spons­ibly isn’t a thing. The only so­cially ac­cept­able way to not spend money is to not have money. Thus, there is a high ef­fect­ive ‘tax’ on sav­ings.

In such situ­ations, not only is risk not so bad, it can be act­ively great. If your risky bet pays off, you can have enough money for big pur­chases or even to es­cape your poverty trap. If it fails, you would have wasted the money any­way, and now you can con­serve slash mooch off oth­ers. Thus, your goal is to find a way to trans­late cash, which one will in­ev­it­ably lose, into in­ali­en­able prop­erty that can be pro­tec­ted, or skills and con­nec­tions and re­la­tion­ships, or at least ex­per­i­ences one can re­mem­ber.

This isn’t just for poor people. Start-up cul­ture works this way, too, and the only way to get things at reas­on­able prices, in­clud­ing labor, or to be able to raise money, is to clearly have spent everything you have and have no spare re­sources. This is a large por­tion of why start-ups are so stress­ful – you are not al­lowed to have any slack of any kind. I’m likely about to start a new com­pany, and this is the thing that I dread most about the idea.

You Bet Your Life

This is all in con­trast to the grand pro­ject we have been as­signed, of ‘sav­ing for re­tire­ment.’

Older people sav­ing for re­tire­ment in mod­ern de­veloped coun­tries, or at least some of those sav­ing for re­tire­ment, face a spe­cial situ­ation. Un­able to earn ad­di­tional funds, and without fam­il­ies or friends they can count on, their sur­vival or at least qual­ity of life de­pends en­tirely upon their abil­ity to save up money earlier in life to spend later.

If they run out of money, they’ll still get some amount of gov­ern­ment sup­port, and per­haps some amount of fa­milial sup­port, but any re­main­ing years are go­ing to suck. If they die with money in the bank, that money can be passed on to oth­ers, but this is mostly a small be­ne­fit re­l­at­ive to not run­ning out of cash to spend.

Com­pound this with large vari­ance in re­main­ing life span, and highly vari­ant needs for health care and as­sist­ance dur­ing those re­main­ing years, and you have an en­tire pop­u­la­tion pres­sured to furi­ously save every dol­lar they can. Any other use of one’s re­sources is looked at as ir­re­spons­ible.

This is pro­foundly weird and pro­foundly messed up.

It is handled, by most people and by those we trust to ad­vise us, mind­bog­glingly badly.

That’s true even in the cases where the prob­lem defin­i­tion mostly ap­plies to one’s situ­ation, if one is will­ing to as­sume the world will con­tinue mostly as it is, and one is un­able to in­vest in other types of re­sources and ex­pects to have little as­sist­ance from them.

It also leads us, as a so­ci­ety, to treat our sav­ings as the sav­ings, the re­tire­ment sav­ings, and to ap­ply the prin­ciples of that prob­lem to all sav­ing prob­lems, and all risk man­age­ment prob­lems. Young people take ‘risks’ and buy stocks, older people play it ‘safe’ and buy bonds.

If the world were a much more cer­tain place, where we knew how long we would live, in what state of health, and how the eco­nomy and world would do, and everything else we might need money for, and how much money we needed to en­gage in vari­ous activ­it­ies and con­sume vari­ous goods, we could kind of have a tar­get num­ber of dol­lars. There was an ad a few years back that was lit­er­ally this. Each per­son had a gi­ant seven-fig­ure red num­ber they would carry around from place to place, with an oddly ex­act num­ber of dol­lars they ‘needed’ in or­der to be ‘able to’ re­tire. Im­plied was that less than this was fail­ure and would be ter­rible, more than that would be suc­cess and no fur­ther funds re­quired. Now you can rest.

In­stead, at best we have a prob­ab­il­istic dis­tri­bu­tion of how much util­ity one would be able to get from vari­ous amounts of cap­ital, in vari­ous scen­arios in­volving one’s life and how the out­side world is work­ing. Even in this sim­pli­fied prob­lem, how does one then ‘play it safe’? At best one can re­duce vari­ance from some ‘nor­mal’ shocks like a de­cline in the stock mar­ket, while still be­ing ex­posed to oth­ers, and likely not pro­tect much at all from big­ger risks. No mat­ter what, the bulk of what you have will prob­ably go to waste or be passed on to oth­ers, or else you are risk­ing dis­aster. At a min­imum, you’re ‘bet­ting’ on what to do with and where to spend the rest of your life, and there you are very much all-in. Odd for someone who is about to die to even try to ‘play it safe.’