It IS relevant.
If you have $1,000,000 and I have $1,000 and we both put up $1,000 to invest you have risked 0.1% of your what you have. I have risked 100% of what I have.
Our individual risk is distinctly different despite the same stakes.
What you said earlier:
The title of this thread was not “Understanding Investment Risk”.
It was “Understanding Risk”.
The OP never claimed to be explaining the concept of “investment risk”, he was explaining “risk”. Fine. But you cannot fully explain risk if you only focus on one of the five different meanings for the word. Like I said before, had the title been “Understanding Investment Risk”, then there wouldn’t be any disagreement.
Since you seem to like the “go to x and see what they say” type arguments, why don’t you go to a risk assessor and tell them that what they consider to be a “risk”, is in fact, not a “risk” at all, and that they have been wasting their lives at meaningless careers.
Or, just admit that “risk” has more than one meaning, and that the OP purported to explain “risk”, and did a woeful job of it.
Investment risk ≠ risk.
That life-circumstances ratio is irrelevant to the returns you are entitled to receive.
Yes, yes, yes, your “overall grand scheme-of-life risk” is different from the millionaire but comparing that is pointless.
Suppose the millionaire is investing 0.1% of his money while you invest 100% but the millionaire is bald, overweight, grotesque and hasn’t had sex in 20 years. His whole validation in life is money. You on the other hand get hot loving every night and even if you lost 100% of your bank account, you still have your sweet honey to hold you during the tough times.
The millionaire would face severe shame and suicidal tendencies if he lost that 0.1% while you would just remind yourself that “money isn’t everything.”
Now who takes more “risk”?
As I said, comparing particular life situations is pointless and stupid. We are already different in why or how we bring dollar amounts to the table. Those non-monetary factors have no relevance on the returns (profit) that we are entitled to.
Yes but the OP post #1 explained the context of the title. The end game was sharing of profits and to work backward from that, you come to “investment risk”.
But… even if the OP titled it “Investment Risk”, I really don’t think this thread would turn out that much differently.
Profits and equity do not come from sob stories about bad knees or breathing toxic fumes. Profits go to those who invest money. I thought that’s what the OP was trying to explain.
I believe the OP actually did in post #1.
It is NOT pointless.
That is what risk is!
It is not that we both put the same amount into the pot. It is what that amount means to us.
Take the poker example.
I bet $1000. You might have $500 in front of you or $5000 in front of you. Your decision to call the bet is absolutely informed by what you currently have. You can go all-in and hope things work out (if you have $500). If you lose you are out of the game. Or you can call (if you have $5000) and if you lose then no biggie. You can play another hand.
If you do not understand this I want to play poker with you.
But you cannot compare subjective fuzzy things such as life circumstances and what “amount X means to person Y.” Your ratio of investment-as%-networth is as flawed as any other formula you want to use.
The fact that you even attempt to do so just highlights that certain philosophical issues are important to you. Well, I also favor my set of non-monetary philosophical issues but they don’t matter. There’s no point in comparing them to dole out “fairness” or “profits”.
But it the extra piles of chips you have in front of you are IRRELEVANT to the payout of that particular hand. Likewise, the life circumstances surrounding an investment into a startup business are irrelevant to the payout of that particular business.
Some quotes from the OP:
Claiming that the dishwasher does not risk being in the poor house if the restaurant closes.
Implying that he alone knows what “risk” is, that everyone else is wrong.
Again, no mention of “investment risk”, and the high & mighty attitude that he is the sole harbinger of truth, and we are all wrong.
Again, this time after Evil Captor made a good point, that everyone else was talking about “risk” in a general sense, while he was talking about it in a very narrow sense.
Starting to see a pattern yet?
Didn’t I tell everybody to Google “Kelly Criterion”? If you did and didn’t understand, start a GQ thread for enlightenment. We’re trying to fight ignorance here, but you have to help too.
Yes I certainly do!
A few more comments about these word games…
The exchange was:
You see, it really doesn’t matter if emacknight originally titled it “Investment Risk.”
The tendency for anyone who disagrees is to mangle any and all words until it suits their particular idealogical beliefs.
If the OP was “Understanding Investment Risk”, we’d have posters pleading that “investment” should also cover “investment of physical labor, sweat, etc? I don’t accept your limited definition of investment.”
If those posters then kept using that approach because they felt that the OP left the door open by titling it “Investment Risk” instead of “Capital Investment Risk” , the door would still be open because then the word “capital” would be semantically beat to death. “Shouldn’t capital include sweat and physical labor? I don’t accept your limited definition of capital.”
…and on and on, forever, recursively, until all 500,000 words in the dictionary are used to prove the point that profits go to workers who do not invest money at the beginning.
Pick any title with any words and that’s what will happen. Resistance is futile.
How about we all pretend that all 500,000 words have been beat to death in this thread and call it a day? Any and all words can be used to describe the quintessential effort provided by paid employees.
Not relevant. Kelly Criterion is about a series of bets.
I have no idea what you’re talking about here. I don’t even disagree with the point of the OP (that employees should get paid, and investors should take the profit). I took issue with the arrogance of the OP in assuming that he was the sole authority on what constituted “risk”, despit being shown, via dictionary definition, that the word encompasses far more than he thinks. I also disagreed that the restaurant owner was the only one who risked being in the poorhouse if the restaurant closed. The OP is clearly, completely and utterly wrong on both points.
As I said earlier:
Wrong again.
The series can be as short as 1.
or investments.
Oh please. The fact that that the series can be 1 is simply a consequence of mathematical self-consistency and is an academic point. It is not related to the real world use of Kelly Criterion.
Please understand the difference between the pedantic use of math vs its actual use especially if you’re going to try and bring it up in a thread.
In any case, it’s not relevant.
Wow!! You were wrong that it’s irrelevant; I mentioned that.
You were wrong to imply that bets and investments are different in this context; I mentioned that.
I wondered where you were confused. Perhaps, your use of “series” meant that that you thought that the notion didn’t apply to a single investment under discussion. So I tried to be helpful if that were your confusion.
And now you write “simply a consequence of mathematical self-consistency and is an academic point” and call me pedantic! :smack:
Whatever.
Anyway, this subthread began when Whack-a-Mole challenged you to a game of poker. Based on your responses, I know who I’m betting on. 
I never implied or meant to imply that bets and investments are different.
The payout from that particular business in relation to the initial point-in-time investment of that business is not something you model with Kelly Criterion.
Have you ever actually used Kelly Criterion?
I guess you’re hung up on Kelly Criterion because of multiple poker hands? I’m saying those extra hands under consideration and its analogy to multiple business investment decisions is not relevant.
The price is the same from the viewpoint of the store. Their perceived price might be different.
Here’s an experiment we discuss in our behavioral economics class. You have two sets of people buying things - 1 a calculator for $20 and one a disk, say, for $120. You tell both sets of people that if they drive 10 miles to another store they can get a $10 discount. Do they do it?
The people buying the $20 item are far, far more likely to do it than the people buying the $120 item, though the discounts are exactly identical, and the cost/benefit of driving is exactly identical. We evaluate based on percentages as much as on absolute numbers. Think of how relatively little effort people spend on evaluating house offer deltas which might be as much as the price of a car but just 5% of the house price.
Risk means nothing except in the context of how the perception of risk drives behavior. Saying risk is only counted as an absolute dollar amount makes the whole exercise pointless.
I don’t see your gambler scenario as the same as your restauranteur, unless the guy’s running a roach-coach one man operation, performing all tasks.
A sit-down restaurant is more complicated, relying on expertise and abilities that the owner cannot perform himself.
I suggest the scenario is more like this: there’s a paralyzed gambler who has $20 to bet.
He has 3 helpers, one guy suggests what casino to go to (like the chef-picking a menu), a gal who picks a number or color to bet on (the waitress-suggesting meals to customers), and a guy who actually puts the chip down for the gamber because he cannot himself (the dishwasher). Each helper gets 25 cents.
The bet wins. Should the paralyzed guy get the whole payout? I say no. Nor do I think the 3 helpers deserve a 1/4, but certainly more than the 25 cents they got.
Don’t forget that most gamblers don’t just gamble for the rewards - the action itself is part of the compulsion to play - and it’s not free. Think of the 75 cents paid before the actual bet as the vig. And so the salaries of the chef, waitress and dishwasher should be considered part of the price to be in the game.
So it is the distinction between a series of only one and multiple bets that has you stymied here, after all? And, despite your ferociously pedantic response, it was my comment “The series can be as short as 1” that would have fought your ignorance, had you the grace to heed it?
As a thought experiment, imagine you’re gambling and, because of an external schedule, you know your next bet is the last bet of this session. Does your proper bet-size now deviate from its Kelly optimum?
And the sub-subthread did arise in the context of a poker game, but even in the earlier context (a man with $10 million contemplating a $1 million investment) is it hard to grasp that this investment is one of a series of further investments? (Relevant, of course, only should you continue to claim, erroneously, that Kelly’s Criterion requires a series of more than 1.)
Two friends decide to bet on the flip of a coin, each puts down $100.
They each risk the same $100, and have the same 50/50 odds of success or failure.
The issue most face in this thread is the question of is that risk acceptable? If one is rich that $100 is chump change, if the other is poor that $100 is everything he has.
What most are describing as “risk” in that scenario is not in fact risk, but risk tolerance.
Both friends have the same risk ($100) and the same odds of losing it (50/50). It is now up to each individual player to decide if that risk is acceptable to him/her. Do she have a tolerance for risk? We know the potential downside, $100 loss, and we know the potential upside, $100.
If the super sad poor guy is so poor he can’t risk losing $100, he shouldn’t be betting.
Now, back to the OP to again understand risk:
-> Owner puts up $10,000 and runs the restaurant unsuccessfully for a year. At the end she closes it, liquidates, and ends up losing all $10,000. She also didn’t get a salary for the year because as the sole investor she is paid from the profits (dividends).
-> Dishwasher invested nothing. She showed up, worked hard, got paid*. At the end of the unsuccessful year she is now $20,000 richer for her time spent. The idea that the dishwasher is out of a job has no relevance to this discussion. Her employment is based entirely on the health of the industry, not on the restaurant.
Both are out of a job, but who lost more? Who gained?
Tell me again how much the dishwasher risked.
*In this scenario I am assuming enough solvency to pay staff and creditors.
We are talking about 2 different modeling scenarios.
As I said before, “The payout from that particular business in relation to the initial point-in-time investment of that business is not something you model with Kelly Criterion.”
If you do not understand that one sentence, you truly do not understand Kelly Criterion.
It isn’t hard to grasp, but it isn’t not relevant to my comments. It’s also not relevant to the OPs initial post.