Fundr Facts: The Data Behind Portfolio Diversification
Updated: Nov 30, 2020
One of the most common questions we get asked about Fundr by investors is: Should I invest in the entire portfolio on the platform?
While most investors agree that creating a diversified portfolio of all your investments is a smart strategy, the idea of a diversified portfolio of startups is less common. Why? In the startup technology sector, investors are looking for unicorns, those one-in-a-million ideas that will provide a huge return on investment. Investors often feel they’ll have a better chance at identifying this unicorn if they evaluate and choose it themselves.
The challenge is that while startups and the technology they employ drive innovation in our culture, traditional mechanisms of investing leave so many of those good ideas behind, because most investors find their investments from inside of their personal, professional, or geographic networks, without the time or capacity to find viable startups outside of those networks. Angel investors - without access to a diverse group of startups - often stick to a handful of startup investments per year, and mostly operate at a loss. Moreover, there are a number of biases that come into play that could blind investors to a world-changing idea. By its nature, if something is going to disrupt innovation, it will likely not follow patterns of past success.
At Fundr, we assert that startup investing should look a lot more like investments in other sectors: diversified and steeped in due diligence. Research by the Kauffman Foundation and the Angel Investor Performance Project (AIPP) shows the strongest chance any investor has at success in startup investing is with a diverse portfolio. In fact, most angel investors would see better returns randomly putting money into as many credible startups as possible than choosing one themselves. Because startup investing can be risky, a larger group of investees is necessary to mitigate against losses across the portfolio.
Right Side Capital Management, which has a portfolio of over 1,000 pre-seed investments, used data visualization to showcase the opportunity for investors. The visualization shows us increased returns as the number of startups in the portfolio increases. A similar analysis of the data by Alex LaPadre of Angie’s List shows that moving from investing in a few startups to at minimum 20 startups increases the odds of breaking even from 83 percent to 99 percent, and the odds of tripling the investment increases from 58 percent to 67 percent. At 500 startups, the odds of tripling the investment is 96 percent.
Looking at the data, portfolio diversification seems like a no-brainer. The “why” is clear. It’s the “how” that needs support. The same AIPP data shows that investor due diligence and ongoing participation like mentoring, board membership, and financial monitoring with investees has an outsized relationship to returns. Fundr was created to bridge the gap between investors and startups, with a focus on creating deeply researched, diverse portfolios and providing the tools that investors need to stay on top of their investments - all in one platform.