As Matt explained yesterday, we spent the past year sitting down with some of the world’s most successful early-stage investors.
These folks have made fortunes backing private companies.
But let’s be clear: they didn’t reap these rewards without taking on risk.
So one of the critical concepts we researched was how they handled downside protection –
In other words: How do these folks ensure they don’t “go broke”?
Well, as we came to learn, 99% of these investors share a simple strategy.
We’ve made this strategy the cornerstone of our private investing process...
And if you’re serious about making money as an angel investor, you should make it your cornerstone, too.
You can earn tremendous returns when you invest in a company early enough.
In fact, angel investors are able to earn huge returns even with companies that are “duds” in the stock market.
Let’s look at a couple of recent market events so I can show you what I mean.
Facebook (NASDAQ: FB) had a disaster of an IPO...
Its value dropped by 50% within three months.
But investors who got in early, when it was still private, made out like bandits:
An early investor named Peter Thiel earned $1 billion when the company IPO’d.
Essentially, he turned every $1,000 he invested into $2 million.
He was able to achieve this because he got in early:
He owned his stock at such a low price that Facebook shares could have fallen by another 50% – and he still would have made a fortune.
Another example is Zynga, the gaming company.
Zynga once traded at $14.69, giving the company a market cap of about $13 billion.
Today, its shares trade at about $2.35.
But even with an 80%+ price decline, investors who backed Zynga when it was still private are pocketing huge profits:
You see, back in 2008, when Zynga was still private, early investors bought stock at $0.05 per share – that’s just 5 pennies.
So even with the stock at $2.35, early investors are still up 47 times their money.
That is the power of getting in early.
But to be clear, not every company will IPO, or turn into Facebook or Zynga...
As we came to learn, even for the most successful investors, home runs are few and far between.
Most professional investors anticipate that 10% or 20% of their investments will be big “winners.”
Sure, a bunch of the companies they invest in might do “ok” – meaning, the investor might get his money back or earn a small profit...
But that’s not how they’re making their fortunes.
Let’s look at Peter Thiel again as an example:
For every $1,000 he put into Facebook, he got back $2 million.
That’s a 200,000% return.
For argument’s sake, let’s assume that he also invested $1,000 into 19 other start-ups. So in total, he built a $20,000 angel portfolio.
Even if every single one of those 19 other companies went bankrupt – literally, if they all went to zero – his Facebook profits would more than make up for his losses.
He’d still be sitting on $2 million.
Simple Rule for Protecting Your Downside
But here’s the rub:
It’s tough to predict which companies will be homeruns, and which will fail.
Professional angel investors understand this, so they use a simple strategy to maximize their upside while protecting their downside:
First, they diversify their portfolio across many investments.
And secondly, they allocate only a small portion of their assets to angel investing.
By spreading their bets, they increase the likelihood of getting a winner like Facebook or Zynga – and because of their asset allocation, no matter what happens, they still have plenty of capital in more conservative investments.
Improving Your Odds
These two concepts – diversification and asset allocation – should become the cornerstone of your investment strategy.
Let me give you a good rule-of-thumb now for determining your asset allocation:
Take your age, subtract it from 80, then divide the result by 2...
That gives you the maximum percentage of your portfolio to allocate to angel investments.
So, for example, if you’re 50-years-old, you should invest a maximum of 15% of your investable assets into the private market. (80-50 divided by 2 = 15.)
As we dive even deeper into The Angel Initiative over the next few weeks, we’ll share another valuable formula with you:
It’ll help you calculate the specific number of companies you should invest in, as well as the dollar amount you should invest into each.
Be on the look out for it later this month.