Investing in start-ups and scale-ups is considered risky compared to other asset classes like publicly traded stocks or bonds. However, there is always a way to reduce your risk by simply building a diversified portfolio, and we’ll explain why.
First of all, it is important to understand how risk works, so let’s start by dividing the concept into two categories: systematic risk and unsystematic risk.
1. Diversifiable or Unsystematic risk
This is the type of risk you can control by investing in different ventures and compensating the bad picks with the good ones. It is a way to reduce your dependence on factors that are unique to each start-up, like the managerial performance of the founding team, consumer interest and demand for the product or service, etc. The solution here would be to invest in various asset classes and in various industries to minimise the overall risk.
2. Market or Systematic risk
This category of risks influences one or several asset classes and is more commonly known as undiversifiable risk. Putting money into more ventures does not help reduce your exposure since all investments are affected by the broader economic and political environment. A good way to illustrate this point is by looking at the next example.
The Burst of the Dot-com bubble: Between 1995 and 1999, the equity value of internet companies grew significantly before collapsing a few years later. So, even if you had a diversified portfolio of e-commerce start-ups in 2000, it is likely that all your investments would have been impacted since the market became aware of the overvaluation of these companies which led to a sudden decrease in their value and the burst of the bubble.
Portfolio diversification may not be the most attractive of investment topics. Still, many agree that diversification is the most important component in helping you reach your long-range financial goals while minimising your risk.
When investing in young enterprises through MMI, a good rule to follow would be the 10/10/10 rule: you should only invest 10% of your savings you can set aside for the next 10 years, in at least 10 companies.
Keep in mind, however, that there is no such thing as zero risk, no matter how much diversification you do. You can however try to cancel out the unsystematic risk as much as possible by investing in different industries but also in various asset classes.
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