The Worst Wealthy Investor I Know

By Matthew Milner, on Wednesday, January 11, 2017

Let me tell you about a guy I know.

Based on his investment track record, you’d think he’d be broke by now.

For example, on one investment he made, he lost more than $25 million.

More recently, he made 21 different investments—and almost half of them went belly-up.

But here’s the thing. Despite these flameouts, he’s become one of the world’s most famous investors.

In fact, his name turned up in Hillary Clinton’s “hacked” emails, where her team recognized him as a “billionaire” and one of the biggest investors in New York.

What’s going on here? How did this guy become so famous and wealthy?

Easy. And it all comes down to one thing...

Meet Fred Wilson

The investor I’m talking about is Fred Wilson.

Fred is the founding partner of one of the most successful venture capital firms in the world: Union Square Ventures.

Fred’s investments include “homeruns” like Twitter, Tumblr, Twilio and Etsy.

But he’s had plenty of “losers” too, including Kozmo, the same-day delivery start-up that raised $250 million and then promptly went out of business.

Last week on his blog, Fred summed up his philosophy on venture investing—and it’s something I want you to keep in mind, because it’s critical to your success as an early-stage investor.

“The beauty of the VC business is you don’t have to be right that often, as long as you are right about something big.”

Fred’s Math

To see what he means, let’s review Fred’s investment track record.

In Union Square Ventures’ first fund, he made 21 investments.

On 9 of those 21 investments, he lost nearly 100% of his money.

Considering how awful that sounds, you might be surprised to learn that, overall, the fund was still wildly successful.

How can that be?

Simple. The winners were so big that they more than made up for the losers.

For example, on 5 of his winners, he made 115x, 82x, 68x, 30x, and 21x.

To make the math easy, let’s say he invested $50,000 into each one. So across 21 investments, that’s just over $1 million.

Based solely on the five winning investments listed above, you’ll see that, overall, Fred turned that $1 million into $15.8 million.

Think about that…

He could have lost 100% of his capital on 16 out of 21 investments—a 75% failure rate!—and he still would have made more than 15 times his money.

But now you need to understand something very important about all this…

It’s the key to understanding how Fred’s returns work out this way consistently.

Start-Up Math In a Nutshell

You see, professionals investors like Fred don’t just invest in a start-up or two and expect the math to work out to their advantage…

Over the course of several years, they build a portfolio of start-ups.

Why?

Because they understand that, unlike the stock market, where you might be in 10 or so positions at any one time, early-stage investing requires far more diversification.

At a minimum, it requires investing in 25 to 50 companies. And investing in 100 of them would be even better.

It takes time to build up a portfolio of that size. But once it gets built, the professionals expect the math to end up looking like this:

  • In a portfolio of 100 companies, about 30% will fail, returning zero.
  • Another 40% might break even or return a small profit.
  • And the remaining 30% will be “winners” — investments that can return about 10 times your money, and sometimes far more.

If you calculate the math based on 100 investments of equal size, you’ll see that the returns from the overall portfolio add up to three to four times the initial investment.

Since this happens over the course of several years, that equates to an annualized return of 20% to 30%.

And here’s the best part: this math is exactly the same whether you’re talking about professional investors like Fred, or Angel investors like you and me.

In fact, in a study conducted by The Kauffman Foundation, a large non-profit that studies entrepreneurship, the historical average return for Angel investors has been about 27% per year.

And as you’ve seen with Fred, sometimes you can earn far more than that...

You Don’t Need to be Right to be Rich

That’s the beauty of early-stage investing:

You can make small bets on dozens of “high-risk” companies...

And as long as you’re right just a handful of times, you could earn incredible returns.

This is one of the core reasons why Wayne and I believe that all investors should have at least a portion of their portfolio in early-stage investments.

Happy Investing.

Best Regards,
Matthew Milner

Founder
Crowdability.com

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