In the ever-evolving world of investing, Australians are always searching for strategies that provide an edge without exposing them to unnecessary risk. The Kelly Criterion, a mathematical formula developed in the 1950s to optimise betting strategies, is experiencing a resurgence—not at the racetrack, but on the ASX and in personal portfolios across the country. As the 2025 financial landscape grows increasingly volatile, understanding and applying the Kelly Criterion could make the difference between steady growth and costly mistakes.
What Is the Kelly Criterion?
The Kelly Criterion is a formula designed to determine the optimal size of a series of bets (or investments) to maximise long-term wealth while minimising the risk of total loss. Originally crafted by John L. Kelly Jr., an engineer at Bell Labs, its logic has been adopted by professional gamblers, poker players, and—more recently—hedge fund managers and retail investors.
At its core, the Kelly formula weighs the potential return of an investment against the probability of success and the odds being offered. Mathematically, it is expressed as:
- f* = (bp – q) / b
Where:
- f* = fraction of capital to wager
- b = net odds received on the wager (i.e., how much you win per dollar bet)
- p = probability of winning
- q = probability of losing (1 – p)
In investment terms, think of “betting” as allocating a percentage of your portfolio to a given asset or opportunity.
Why the Kelly Criterion Matters in 2025
Australian investors in 2025 face a unique mix of challenges and opportunities:
- Interest rates remain elevated after the RBA’s tightening cycle, squeezing traditional savings but offering opportunities in fixed income.
- ASX volatility is high as commodity prices and global tech stocks fluctuate.
- More retail investors are using sophisticated trading platforms and seeking to automate portfolio decisions.
In this environment, the Kelly Criterion offers a disciplined approach. Rather than going ‘all in’ or spreading investments too thin, the formula provides a rational way to size each position based on the perceived edge and risk. For example, if you believe an ASX-listed mining stock has a 60% chance of outperforming the market and your analysis suggests a potential 20% gain versus a 10% loss, the Kelly formula helps determine how much of your capital to allocate—without risking catastrophic losses if your thesis is wrong.
Real-World Examples and Policy Implications
Consider an Australian investor weighing a position in green energy shares after the 2025 Federal Budget’s expansion of tax credits for renewables. The odds of these stocks outperforming have arguably improved, but the risks remain. By plugging realistic probabilities and expected returns into the Kelly formula, the investor avoids emotional overexposure and remains grounded in data-driven decision-making.
Similarly, SMSF trustees managing retirement savings can use the Kelly Criterion to decide how aggressively to pursue new asset classes—like private credit or infrastructure—now more accessible thanks to recent regulatory reforms. With the ATO increasing scrutiny on SMSF risk profiles in 2025, using a formulaic approach like Kelly can also help justify decisions to auditors or family members.
Key ways investors are using the Kelly Criterion in 2025:
- Algorithmic trading: Many robo-advisers and trading bots now incorporate Kelly sizing to optimise trades.
- Portfolio rebalancing: DIY investors use it to determine when to add to winners or cut back on losers.
- Risk management: Fund managers cite Kelly sizing in compliance documents as a best-practice methodology.
Common Pitfalls and How to Avoid Them
While the Kelly Criterion is elegant, it relies heavily on accurate estimation of probabilities and returns—an area where even professionals can stumble. Overestimating your edge leads to overbetting, while underestimating it can make the strategy too conservative.
- Don’t rely solely on gut feel: Use robust research, historical data, and scenario analysis to estimate probabilities.
- Consider the ‘fractional Kelly’ approach: Many investors use half-Kelly or quarter-Kelly sizing to reduce volatility and drawdown risk.
- Reassess regularly: As market conditions and information change, update your inputs to avoid outdated assumptions.
For Australian investors, the Kelly Criterion is not a magic bullet—but it’s a powerful tool for introducing discipline and logic into position sizing, especially as markets become more unpredictable and policy changes add new variables to the mix.
