The art and science of angel investing: how to diversify your portfolio

Diversification is common sense for any type of investor. There’s even a saying that it’s better to be roughly right than exactly wrong. And knowing that 90% of startups fail, betting on one horse to become a unicorn is a gamble you don’t want to take.

Diversifying your angel investments across multiple startups is fundamentally risk management. Some startups will fail sooner or later; when one flops, others may succeed and balance the losses. Let’s look at different diversification strategies and how to strike the right balance between a diverse and a watered-down portfolio.

Understanding diversification: finding the right balance

Diversification is not just about investing in more than one startup. You can invest in hundreds of companies but if all those companies are similar, you still don’t have a diverse portfolio. So what exactly is considered diversification, and how to strike the right balance?

Diversification in its essence is about not putting all your eggs in one basket – this means spreading your investments across different companies, industries, stages etc.

How diverse is diverse enough?

This depends on various factors such as your risk tolerance, investment strategy, preferred industries, etc. Some say that anything below 20 startups is too much of a risk, others are comfortable with 10 – it’s hard to tell what suits you.

However, there are some general investment diversification guidelines to consider:

1. The number of investments – while there's no magic number, having at least 10-20 investments is a solid foundation for diversification.
2. The variety of investments – seek variety in terms of industries, stages, geographies, and founders/teams. This mitigates the risk of any single sector or startup.
3. The risk-return balance – aim for a healthy mix of lower-risk and higher-risk investments.

How diverse is too diverse?

It's also crucial to avoid dilution where diversification waters down portfolio performance. This occurs when each added investment lowers the expected return more than it reduces the risks.

A telltale sign of over-diversification is not being able to keep up with your portfolio. If you can't keep track of individual investments or adequately research investment opportunities, you’re probably losing focus.

5 main diversification strategies

1. Industry diversification – by spreading your investments across different sectors like software, healthcare, and finance, you're not overly reliant on the success or failure of a single industry. If one industry faces challenges, other sectors keep your portfolio afloat.
2. Company stage diversification – investing in startups at different stages helps you build a well-rounded portfolio. Early-stage startups usually offer high growth potential but come with higher risks, while later-stage startups have reached certain stability but offer lower growth potential.
3. Geographical diversification – it’s tempting to invest in your home region or country, but this leaves you with a very un-diversified market, economic landscape, and regulatory landscape. Investing in startups across various regions lets you tap into diverse markets and emerging trends.
4. Founders and teams – investing in founders with diverse backgrounds and networks is not only socially beneficial but also makes business sense. Various studies and statistics show that startups with diverse teams are significantly more profitable than their peers.
5. Investment structures – explore investment structures and variables to gain access to a wider range of investment opportunities. Angel funds, syndicates, or angel networks also help you share responsibilities, due diligence, and expertise to invest better and faster.

How much time and money do you need to build a diverse portfolio?

It's important to understand that building a well-diversified angel investment portfolio is not a one-time endeavour but an ongoing process. Depending on your capital and investment opportunities, it may take years. Similarly to any long-term investing, you need patience, persistence, and thorough research.

Angel investments are typically long-term commitments therefore finding and validating investment opportunities takes time. Different startups also have different minimum investment requirements. No one has an infinite amount of money and/or high-quality investment opportunities. You can start with smaller investments, learn along the way, adjust your strategy, and expand as your capital grows.

7 Commandments of building a well-diversified angel investment portfolio

Now that we understand the basics, how do you build a well-diversified investment portfolio in reality? The best way to maximize your success and manage risks is to think things through, be selective, and follow the plan. Here are the key strategies.

1. Research, research, research

Don’t get hasty and always do thorough research on the startups you're considering for investment. Don’t get carried away with the “spray and pray” approach, as it can burn through your money faster than you think. Read more about doing your due diligence and the green flags and red flags of startup investing from our blog.

2. Determine a clear investment strategy

Establish a clear investment strategy based on your means, goals, and risk tolerance. Determine the sectors, stages, geographic locations, and other parameters that help you filter suitable investment opportunities.

3. Define your portfolio allocation

Define the percentage of your total capital you're willing to allocate to each startup, industry, stage, region, etc., based on your diversification goals and investment strategy. Keep in mind that angel investments are typically illiquid and make sure you keep sufficient free capital for other financial obligations.

4. Network but don’t run with the herd

Angel networks and syndicates give you access to better investment opportunities and other investors’ expertise. It also helps you share due diligence and save time. But stay conscious about herd mentality. Don’t follow the crowd blindly, stay disciplined, rely on your research, and try to keep a balanced perspective.

5. Join forces with other investors

Co-investing with other angel investors allows you to pool resources. This way you can diversify your portfolio faster without individually sourcing and evaluating every opportunity.

6. Monitor, evaluate, repeat

Regularly monitor the performance of your investments, stay informed about market trends, industry dynamics, and any relevant developments that may impact your portfolio. Stay engaged with the startups in which you've invested, and review their financial updates, milestones, and market landscape. This way you can make informed decisions about adjusting your strategy, allocations, potential exits, or follow-on investments. Also, if you’re a more hands-on type, you can help them with your expertise and guidance.

7. Manage risks rationally and proactively

Define a risk-management and exit strategy, e.g. the key events or triggers to re-evaluate or exit an investment. We’re all emotional beings and it's easy to let fear, greed, or impatience cloud your judgment. Rely on hard numbers, stick with your strategy, and avoid succumbing to impulses.

Conclusion: diversifying your portfolio is both art and science

Building a well-diversified portfolio is a constant process that takes time, effort, constant learning, and adjustment. Setbacks happen, but they’re an opportunity to grow as an investor. Remember that angel investing is not just about financial returns. It's also about supporting innovation and empowering tomorrow’s visionaries – what an exciting journey to be a part of!

Lastly, surround yourself with a network of experienced investors, mentors, and fellow angels. The saying ‘if you want to go fast, go alone; if you want to go far, go together’ didn’t come from nothing. Good luck and happy diversification!