Five years ago, my parents decided that they also wanted to start investing in some of the top startups in Silicon Valley. They were beginners, and needless to say, I had plenty of advice to share.
Since then, they've been investing alongside me. So far, they have had quite a good run.
If early indicators are to be believed, their portfolio will outperform 90% of professional venture capitalists - and with a little luck, may even land them into the coveted top 5% of professional investor territory.
That's not bad considering my mom (a nurse) and my father (an engineer) spend less than two hours a week on their investments...
These three tips are what I've hammered into my parents since day one. They didn't just help my parents achieve great returns as angel investors; they showed them how to do so in a predictable manner.
These rules are the same ones I wish someone had shared with me when I was starting out.
Of course, I'm no longer a beginner, but I revisit these rules every single week and consider them as I make any new investment. And I shared one of the most important ones with you just last week.
Continuing to follow these tips has allowed me to separate the winning investments from the duds. Today I'm sharing them with you...
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Angel Investing Tip No. 1: Diversify, Diversify, Diversify
In the public markets, wealth managers tout the benefits of diversification. In reality, the mathematical benefits of diversification into public assets starts to max out at around 10 different asset holdings. In your public portfolio, it's much more important to diversify among asset classes than among individual stocks, as public stocks tend to be highly correlated.
In angel investing, the opposite is true - diversification among many different angel investments is the key factor for getting high returns.
Here's why...
Angel investing is an asset class driven by power-law returns. That is because the upside returns are so great in any single angel investment that a single company can make an entire portfolio return 10x or even 100x.
Why is that?
We mortals have a difficult time conceptualizing power-law returns, so let's examine the implications of a 10,000x return on a single investment:
- If you have a 10,000x return in a single asset, you can also have 9,999 companies go to zero and still return a 1x on your entire portfolio.
- If you have a 10,000x return on a single asset, you can also have 99 companies go to zero and still have a 100x or 10,000% return on your portfolio.
- If you have a 10,000x return on a single asset, putting in $100 returns $1 million, and putting in $1,000 returns $10 million!
That is why, when in doubt, it is important to put a little bit of money into every single company.
Which leads me to the next tip...
Angel Investing Tip No. 2: When in Doubt, Don't Pass - Invest the Minimum Instead
Don't let ego get in the way of your next 10,000x return. Rather than deciding whether to invest $10,000 or $0, invest the very minimum - which in many cases can be as low as $100.
Obviously, this doesn't apply for opportunities that don't interest you at all. But if you're on the fence, my de facto strategy is to invest a small amount.
Tip No. 3: Follow the Smart Money
Angel investing allows you to do something quite unique - and that is to invest at the same valuation as top-tier investors who have spent hundreds of hours delicensing a company.
It takes a minimum of 10 years to become a great investor. In order to do so, you must become comfortable following top-tier investors who have put in the work determining what makes for a great company and great investment.
The need to "let go" and defer to highly competent professionals can't be understated for two reasons:
1) Understanding the difference between a bad company and a good company can be learned within a year, but learning the difference between a good company and a great company (a potential 10,000x) takes decades.
2) Lead investors often have access to 10 times more data and management interaction than the typical angel investor.
Do not overthink it... and do not allow your ego to talk you out of a great investment.
With the right tools, anyone can invest like the pros do.
The key is to have a system and stick to it.
I'll be back soon to share the three signals I look for in an early-stage startup.
And in the meantime, don't forget to check out the Angels & Entrepreneurs team's presentation explaining why startups can have an edge during a recession...
You see, Uber, Airbnb, Slack, Pinterest, and Venmo have something big in common - something other than their big names.
These startups were founded during the last recession.
And now, some of the most iconic companies of our time could launch into Fortune 500s during days like today.