David here.

No matter what type of investing you do, you’ve probably heard the same advice: Diversify, diversify, diversify.

It’s a topic that’s been widely discussed and debated for decades. In 1952, American economist Harry Markowitz received the Nobel Prize in Economics for his modern portfolio theory, which argues that an investment’s risk and return profile should not be assessed alone but rather as part of the overall portfolio’s greater whole.

Markowitz found that investors who diversified their assets could achieve similar returns to non-diversified investors… without having to take on more risk.

Modern portfolio theory formed the foundation of the mutual fund industry, which now accounts for over $20 trillion in assets. The debate on what the ideal asset mix is has gone on for well over 50 years.

Most large asset managers advise you to invest in a combination of stocks and bonds. Forward-thinking managers, however, have been recommending startup investments for the past decade… and their clients have significantly outperformed the market.

Today, we’ll talk about the best way to diversify your own portfolio. But first, let’s start with some caveats:

Startup investments are illiquid. Therefore, you shouldn’t invest any money that you need for regular spending purposes.

It’s been shown time and time again that most investors sell at the very worst time (when assets are in the hole) and buy at the very worst time (when assets have gone up a lot). To me, this makes illiquidity a benefit, not a cost. When you can’t pull your capital at any time, you’re much less likely to buy and sell impulsively – plus, you don’t need to watch your assets daily and stress about what to do.

Now that you have this caveat, let’s jump into portfolio construction. To this day, there is great debate as to how much of your money you should invest in startups.

On one side, you have Peter Thiel, who invests 75% of his assets into startup companies. He believes there is low correlation between different private stocks, and that the returns are just better in the private market.
But Thiel’s approach is far from the norm. Most asset managers would recommend that a portfolio with no immediate liquidity needs should own roughly 5-10% in startup equity.

What’s more important than your overall startup allocation, though, is how you diversify your portfolio within the startup category.

Angel investing is what’s known as a “hits business.” That means you need to invest into as many companies as possible – in as many different verticals as possible (fintech, consumer, hardware, etc.) – to maximize your chance of getting a “hit.”

Because there is less correlation between two startups than what you’d see between a private and public company in the same vertical, the number and diversification within your startup portfolio is paramount.

Of course, then you run into a unique problem: You can’t possibly know everything about dozens of different verticals at once.

When you invest in startups, make sure you’re following smart money into each deal, and that you have the right investors coming in with you.

The Angels & Entrepreneurs Network was founded to provide that exact resource to the tens of thousands of angels and readers who have joined our ranks so far. Not everybody lives in San Francisco, L.A., or New York, and despite the popularity of this asset class, it’s still relatively rare to meet other angel investors organically.

The Network is a virtual meeting place for angels and entrepreneurs around the world… Not to mention a place to find world-class startup investment opportunities, some of which I’ve invested into myself. In other words, it makes “following smart money” effortless.

Just click here to check it out.

I’ll be back tomorrow with some info you won’t want to miss.

Very best,

David Weisburd