Do Startups Belong in Your Portfolio?

Classic portfolio strategy recommends a diversity of risk levels.

Low-risk investments are used to beat inflation, save for retirement, or for legacy purposes. High-risk investments are for building wealth.

Most investors put money into conservative investments like index funds and Roth IRAs, but often forget to include a high-risk component in their portfolios.

Angel investing is the ultimate investment type for filling the high-risk portion of your portfolio. It brings the highest returns and offers unparalleled potential for wealth creation.

How Many Startups Should You Invest In?

I see many first-time investors come into the angel investing world with a big misconception.

Stories of hyper-successful startups like Uber and Airbnb are a part of pop culture now.

Because of this, many seem to think that angel investing is all about unicorn hunting, in other words, searching for that one perfect deal that will make you millions.

The problem with this is that it makes investors set the bar too high. Most people don’t believe they will be able to spot the next Facebook. What happens is they end up spending too much time searching, researching, and conducting due diligence and not enough time investing.

The truth is, long-term profits in startup investing come from throwing out a large net and investing in many companies.

You don’t just need startup investments in your portfolio, you need a portfolio of startup investments.

Statistics show that the number of deals is more important than the quality of any single deal.

According to the study, Startup Growth and Venture Returns by AngelList, investors could increase their returns by broadly investing in every credible deal they find instead of only the best deals they find.

So, investing in anything legit is better than spending hours on due diligence? While that sounds almost impossible, it's true nevertheless.

Turns out, the index of startup opportunities beats the returns of 90% of startup investors, even experienced ones.

What does this mean?

For starters, it means the private market is incredibly healthy. What's more, it shows that, on average, investing in more startups can increase your chances of success.

Now, you don't need to go investing in hundreds of companies a year to turn a profit. There are methods you can use on a smaller scale, even for beginners.

Strategies for Angel Investing

We can start to base our investment strategy around two simple facts.

  1. Most startup investments will fail.

  2. Successful startup investments yield huge returns.

Understanding this, the name of the game is making sure your wins can cover your losses.

Based on our data, the magic number of startup investments to make this work is ten or more.

On average, ten startup investments at any given time gives investors a high chance of securing at least one profitable exit.

Let me break this down.

If you invest in ten startups, four of them will outright fail on average.

Now we have six investments left. About five of them will break even or give you a small profit.

Finally, the one remaining startup will be a significant success.

As we know, returns on a startup investment are substantial, upwards of 10x, 50x, even 100x of your initial investment.

If we elaborate on all this, it’s easy to see that your one-in-ten startup that succeeded will return enough money to pay for all of your losses and net you a hefty profit.

Were you to only invest in one or two startups, it wouldn’t be sustainable or practical. Most likely, you would lose your investment and be discouraged and unable to reinvest.

This is why most serious angel investors will always have between 10 and 25 investments at any given time. You need to play the numbers game to win.

The exact number of startups you should invest in depends on your net worth and risk tolerance.

Investing in more companies is better, but only to a limit. Of course, your angel investing strategy needs to fit with the rest of your finances.

How Much Of My Net Worth Should Be In Startup Investments?

So exactly how much of your net worth should you devote to startup investing? Let’s take a look.

The chart below shows the net worth allocation of 146 affluent angel investors taken from a Center for Venture Research survey. We can see how many angels devoted how much of their net worth to seed funding.

% of Net Worth for Angel Investments1-4% 5-9% 10-14%15-24% 25-50% >50%% of Angel Investors7% 18%25%21%19%9%

We can see that the most common net worth allocation was between 10-14% and that nearly half of all angels invest 10-24% of their net worth in seed funding.

Depending on your net worth and deal-flow, this could be 5, 10, or 100 startups.

The best place to start is simply what you can manage. Start with three or five investments and work your way up.

However, once you get into the big-leagues—investing in 10-25 startups—you need to ensure you have a diverse group of startup investments.

Startup Investment Diversification

Keeping a diverse set of investments is as important in the angel investing world as anywhere else.

Quantity will give you some inherent diversification, but it is important to focus on other dimensions as well.

You can diversify your startup investments by investing in:

  • Startup in different industries

  • Startups in different stages of development

  • Startups led by different types of entrepreneurs

  • Startups taking on different types of risks

Through diversification, you mitigate risk. You don’t need to spend hours on due diligence if you have a good eye for talent and maintain a diverse portfolio of startups.

Think about this—if you invested exclusively into the hospitality and tourism industries pre-COVID-19, your entire investment strategy would have collapsed.

But, if you had some investments in hospitality, some in FinTech, some in education, and some in electric vehicles, you could have averted a crisis, even turned a profit, during a tough market.

Likewise, by investing in some young startups and some mature, you will have an even spread of returns over time.

Returns will come in cycles, some after three years, others after five or ten. You will be able to flip your profit back into investments steadily, rather than waiting for everything to happen at once.

By diversifying across many dimensions, you make up for your personal faults and bad habits as well as changes in the market. This opens you up to a steady, profitable investing future.

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