Diversification for Angel Investors

Brandon Gadoci
Nov 7, 2017 · 4 min read

This post is the first in a series titled Angel Investing & Modern Portfolio Theory Considerations.


As mentioned in my previous post, there are several forces at work which are making it more and more attractive to invest in startups. Specifically tech startups. As legislation loosens, and as information and leadership is more available, accredited investors are sniffing out what angel investment means to them.

One of the things that is unaffected by the increased availability of this asset class is Modern Portfolio Theory, and all the efficiencies and strategies it provides. The results from the collision of this asset of class evolution [startups] and these time tested principals, are 4 questions.

  1. How many companies should I be investing in?
  2. How much should I be investing in each of them?
  3. Which companies should I invest in?
  4. What are the possible effects on my overall investment strategy?

In subsequent posts I’ll be trying to answer each of these questions, but today I’ll start with number one.

How many companies should an Angel Investor invest in?

What, in effect, is being asked here is

How does the concept of diversification apply to early stage startup investing.

Let’s take a quick look at diversification so we can further discuss how it applies to our question.

Popular Wisdom

Diversification is the idea of owning multiple investment positions, such that you are reducing nonsystemic risk (risk that is unique to the individual holding).

work is widely accepted as the standard when it comes to value investing and his ideas in have guided investment principals for some time. Ben made popular the idea that 15 holdings is the magic number when it comes to diversification, after which the introduction of new securities does little to reduce the nonsystemic risk of the overall portfolio.

these ideas further concluded that portfolios consisting as few as 10 and as many as 20 holdings cam offer a standard deviation that is comparable to the market.

With the market in these cases commonly being a large group of publicly traded companies (man times the S&P), it seems it would be a reasonable conclusion that Angel Investors should own more holdings in order to account for the increased amount of risk that is investing in such early stage companies.

For a more specific perspective, let’s turn to the TechCrunch article:where Robert Wiltbank, PhD concludes that somewhere around a dozen investments is a good starting place for new angel investors. He goes on to explain how with 6 investments the median return exceeded 1x the initial investment and at 50 investments the overall return was in the 95th percentile. His findings and comments are based on several studies including the .

So, popular value investing suggests that around 10–20 holdings is sufficient to diversify risk properly and it seems that some Angel Investing Studies confirm this. With that said, one might use this a guideline for their own angel investing portfolio construction. Before we stop there, let’s look first at what renowed financial theorist has to say on the matter.

Counter Point

In his article Bernstein disagrees with the ideas presented above.

In order to investigate this problem, I looked at the stocks constituting the S&P 500 as of 11/30/99, and formed 98 random equally-weighted 15-stock portfolios for the 12/89–11/99 10-year holding period…the TWD of these 15-stock portfolios is [a] staggering — three-quarters of them failed to beat “the market.”

Bernstein further explains

The reason is simple: a grossly disproportionate fraction of the total return came from a very few “superstocks” like Dell Computer, which increased in value over 550 times. If you didn’t have one of the half-dozen or so of these in your portfolio, then you badly lagged the market.

Bernstein goes on to explain that the only way you can truly evaluate the risk reduction by factoring in this selection bias is to own the entire market. You can read the full article .

This should resonate with Angel Investors because of the volatile nature of startups. Most fail and a few make it big. The concept of buying the market really isn’t an option in the private markets like you can do with an index fund in the public markets (though it’s technically impossible to own the market in the public arena too).

So where do we go from here?

To me the above suggests that as much as risk and return are inherently related, perhaps we need to separate them when answer the question How many companies should an Angel Investor invest in.

On one side, there is sufficient evidence that increasing ones holding to some 15 to 20 investments significantly reduces the nonsystematic risk in a portfolio. Further, any additions above that number do little to reduce the the overall risk of loss.

That said, in order to maximize the chances of owning a big winner, one needs to move closer to the 50 holding mark, after which they are not meaningfully increasing said chances. The question is if your position in those securities is meaningful enough to capture significant upside when those deals hit. That’s something I’ll explore in my next post.

What’s Next

In my next article I’ll be exploring how much Angel Investors should invest in each of these holdings to make sure they are addressing the systemic risk portion of the equation.


I should mention that I am not a registered financial advisor (anymore) and I don’t know your unique financial goals. Please consult your investment and/or tax professionals before making any decisions based on my writing.

Brandon Gadoci

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Some #design, some #code, some #businessing. First employee at @datadotworld. Also #fitness #crossfit #foodie #dad #wine #audiophile.