#001: Invest Like Venture Capitalists (Part 1/4): A Financial Home Run is Part of a Strategy and not Luck.
My approach to maximizing the likelihood of harvesting 1000X gains: An investment thesis to hit a life-changing return.
In this series of four posts, I want to show you how I invest a fraction of my money in such a way that the potential return can be outsized, i.e. life-changing.
Thereby, I control the potential downside and maximal possible loss.
If you master this approach, you will have extreme clarity on your investments, expectations and involved risk without getting nervous during downturns or highs of financial markets.
The problem is that most people don’t have a crystal-clear investment strategy with well-defined expectations nor a rigorous approach on executing such a strategy.
You can download the full content of this article (all four parts) as a PDF-presentation at the bottom of this post.
Topics covered in this article
- An investment thesis for 1000X returns (Part 1/4):
Conventional investing vs. the venture capital power law. In conventional investing, the investment goal is typically specified as generating 2%-6% year-over-year (YoY) returns.
In venture capital (VC) the investment goal is to generate an outsized return with potential “unlimited” upside.
I show you how I apply the VC approach to retail investing while having great clarity on my potential maximal loss.
2. Why I invest in Crypto (Part 2/4)?
Until recently, regulation in most countries has prohibited most people to invest in game-changing technologies and companies with outsized-return potential unless you were very wealthy (e.g. a high net-worth individual).
Crypto not only has made such investments accessible to everyone with an internet access (with some exceptions depending on geography).
It also enables us to invest in technologies, projects and companies alongside top-tier venture capitalists (VCs), which is a crucial ingredient in the presented approach.
3. Investment Strategy (Part 3/4):
Retail venture capital investments can be treated like funds. Thus, I want to maximize the likelihood to get an outsized return with respect to my fund-size instead of maximizing the return of a single investment.
Then the fundamental questions to be answered are “How many investments should I pick?“ and “How much money should I invest per pick?“.
I provide answers to these questions as a percentage of net worth regardless of how large or small it is.
This will allow you to exactly quantify the risk you are taking and how to protect the potential downside.
4. How to select the individual investments (Part 4/4)?
Even though nobody can predict the future, there is a systematic way to select investments which have a higher chance to generate outsized returns, especially because in Crypto you have the chance to invest alongside top-tier VC firms.
Maturity of the project and market-capitalization of the currency are also decisive factors.
My investment thesis for 1000X returns
Conventional investment approach
Traditional investment strategies such as investing in bonds, real-estate, stocks, ETFs and the like, typically foresee an expected yearly return on investment (ROI) between 2% and 6% or potentially a little higher.
Obviously, in a bad year the return will be negative (i.e. a book loss or unrealized loss). However, averaged over a decade modest gains can be expected.
For example, imagine you invest today $1,000 in stocks with an expected average yearly return of 5%. Then, in 10 years your investment will be worth $1,551 as you can see from the table below.
If we assume a yearly inflation rate of 1%, your investment will be worth $1,423 because your real interest is 4% (= 5% — 1%). Therefore, the real rate of interest over 10 years will be 42.3% (= $423 / $1,000).
Note that in our example we are assuming theoretical unrealized profits / losses.
If you are planning to realize (i.e. withdraw) your profit in exactly 10 years and the day before you liquidate your investments there is a stock market crash, your gains will be lower or might be entirely wiped out.
That’s why we are referring to average yearly returns of 5%, which means the return could be -2% in one year and +8% in another year, etc.
Now, 42.3% return sounds attractive and such a traditional investment approach might make sense if you aim for steadily increasing your wealth, not lose too much savings due to inflation, and plan for retirement with a multi-decade horizon.
Yet, such a return is certainly not life-changing. Not life-changing by definition means, your life does not change if you realize a 42.3% return over a period of 10 years.
The VC approach
As Marc Andreesssen (co-founder and general partner at top-tier VC firm “Andreessen Horowitz“) states, Venture capital is a game of outliers.
Thereby, each investment is placed as a bet such that if the bet turns out to be a win, you win massively, e.g. your return on investment might be 1000X or higher.
However, on average the chance is small that an investment will be a home run and it is more likely that you will lose a particular investment.
Yet the question to answer in VC is not “what’s the risk my investment will fail?“ but rather “if my investment is successful, how big will it be then?“
Consequently, compared to traditional investing a loss is not quantified by a negative return but rather by having missed the bet that turned out to be a big win.
Therefore, in the VC game you lose if an investment turns out to be massive but it wasn’t your investment.
If you play the game successfully, you will have placed a lot of bets (possibly more than 100), where the majority turns out to be a loss but there is at least 1 big outlier-win that generates an outsized return.
Imagine you invest $1,000 to place 100 bets (i.e. on average you invest $10 per bet). If 99 bets turn out to be a failure and you lose all your money on them but 1 bet massively succeeds and generates a 1000X return, then you win big.
Concretely your “P’n’L“ (a.k.a. profit and loss) statement after 10 years reads
Year 1:
- Total investment: $1,000
- Number of investments 100 (= $10 per investment)
Year 10:
- Failed investments: 99
- Lost money: 99*$10 = $990
- Successes: 1
- Return: 1 x 1000X = $10 x 1,000 = $10,000
Therefore, you bag $10,000 on a $1,000 investment, which is an overall 10X or $9,000 or 900% return on investment compared with the 43% gained with the traditional investment approach (inflation is negligible in the VC-scenario).
Consider now an initial total investment of $2,000 instead of only $1,000.
Assuming again you hit 1 home run (which by no means is guaranteed), then your P’n’L becomes
Year 1:
- Total investment: $2,000
- Number of investments 100 ($20 each)
Year 10:
- Failed investments: 99
- Lost money: 99*$20 = $1,980
- Successes: 1
- Return: 1 x 1000X = $20 x 1,000 = $20,000
Now, you bag $20,000 on a $2,000 investment, which still is an overall of 10X and 900% ROI. But in the first case you gain $9,000 and now you gain $18,000.
You can easily see that these number-games can quickly lead to life-changing ROI scenarios. The questions to answer now are
- How can I increase the likelihood to hit a home run such that it is worth taking the risk?
- How big is the risk compared to the opportunity?
If I knew the opportunity was as marginal as winning the lottery, then the question boils down to: Should I buy lottery tickets worth $2,000?
And if this was the case, I’d rather spend the money on holidays or a gadget I fancy to buy.
Fortunately, there is a systematic approach to follow that significantly increases the chance to hit a home run as you will see if you continue reading.
But let’s first focus on the aspect of quantifying the risk we are taking.
Protecting the downside
Life-changing return is a relative measure. It depends on your current wealth.
If you own $1,000, then earning another $1,000 is life-changing because such a gain doubles your net worth.
Therefore, the common denominator here for everyone to consider is the net worth for both, quantifying life-changing return as well as the risk (a.k.a. potential downside or loss).
I personally don’t invest more than 5% of my (liquid) net worth into venture investments. Thus, I risk to maximally lose 5%.
Since I have the rest of my net worth invested “traditionally“, e.g. in pension funds, bonds and stocks, I could recover a potential loss of 5% on average within a few years as with those investments I expect an average yearly return of minimum 5%.
Can you afford such a risk? Probably yes. But do you want to take such a risk?
Again, it probably depends on how big the opportunity is.
So let’s dig deeper.
In the following posts, you will learn,
- Part 2/4: why Crypto is a great opportunity to apply the VC approach and “invest with the best”;
- Part 3/4: the framework I apply in practice while quantifying 3 scenarios: worst-case, modest-case and best-case with numbers, percentages of potential gains and losses per individual investment and how to minimize regrets;
- Part 4/4: How to assess and select individual investments in practice and how and where to buy them.
Key takeaways
- To maximize your chance to hit a big win you need to apply the VC power law: Increase your chances to hit one home run to win big. You only need one.
- Exactly understand what’s at stake. Quantify the risk as well as the potential gain relative to your net worth.
- Crypto provides a way for people like you and me to apply the VC-investment approach and potentially win big.
Don’t miss the next post: Follow me on Medium or subscribe to this news letter here and learn the details of my strategy and how I maximize my chances to hit a life-changing return.
PDF / Slides
Download the entire content (parts 1 to 4) as a PDF-presentation here (feel free to share it).
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Disclaimer
The views expressed here are those of the author. Certain information contained in here has been obtained from third-party sources. While taken from sources believed to be reliable, the author has not independently verified such information and makes no representations about the enduring accuracy of the information or its appropriateness for a given situation.
This content is provided for informational purposes only, and should not be relied upon as legal, business, investment, or tax advice. You should consult your own advisers as to those matters. References to any securities or digital assets are for illustrative purposes only, and do not constitute an investment recommendation or offer to provide investment advisory services. Furthermore, this content is not directed at nor intended for use by any investors or prospective investors, and may not under any circumstances be relied upon when making a decision to invest. Any investments or companies mentioned, referred to, or described should not be considered as investment recommendation, and there can be no assurance that the investments will be profitable or that other investments made in the future will have similar characteristics or results.
Charts and graphs provided within are for informational purposes solely and should not be relied upon when making any investment decision. Past performance is not indicative of future results. The content speaks only as of the date indicated. Any projections, estimates, forecasts, targets, prospects, and/or opinions expressed in these materials are subject to change without notice and may differ or be contrary to opinions expressed by others.
