Mastering Portfolio Theory: A Guide for Angel Investors on Portfolio Diversification
How can angel investors utilize the concept of portfolio theory in building and diversifying their investment portfolio?
Portfolio theory, a concept in finance that attempts to maximize expected return for a given level of portfolio risk, can be effectively applied by angel investors to build and diversify their investments. Here are some ways how:
Diversification: The fundamental principle of portfolio theory is diversification. By spreading investments across a range of startups, investors can offset potential losses from some with gains from others. Diversifying across industries, geographic regions, and stages of business maturity can also mitigate sector-specific and market risks.
Risk vs Reward: Understanding the risk-reward trade-off of investments is key. While early-stage startups may offer the potential of high returns, they also carry higher risk. Conversely, later-stage startups may offer lower return potential but are often accompanied by lower risk. Balancing your portfolio with a mix of both can optimize the overall risk-return profile.
Correlation between Investments: Minimize risk by investing in startups that are not likely to be affected by the same economic, industry or sector events simultaneously. The lower the correlation, the greater the risk reduction benefit.
Regular Rebalancing: Over time, some investments might outperform others, leading to a shift in the portfolio's risk-return profile. Regularly reviewing and rebalancing the investment portfolio can help maintain its intended risk-return character.
Optimal Number of Investments: Research suggests that having 15-20 investments in a portfolio can significantly reduce risk while maintaining high return potential.
Use of Syndication: Leverage investing syndicates to pool capital, spread risk, gain access to diversified deals, and benefit from collective wisdom and expertise.
By applying the principles of portfolio theory, angel investors can optimize their portfolios, effectively balancing risk and return to achieve their investment objectives. Remember, though, that all startups have a high degree of risk, and past performance is not necessarily indicative of future results.