Don’t let the word “science” intimidate you. This is simple stuff.
Everyone has different risk profiles when it comes to their investments. Typically, a young person will have exposure to riskier stocks that might yield high returns in a bull market, but could also yield a negative return of equal magnitude in a bear market.
The thinking here is that someone who is young is staying invested. So even though riskier stocks might struggle during a downturn, no harm no foul—they’re not selling anyway. Someone who is older in the same market environment wants far less volatility in their stocks because there’s a good chance they’re living off of their investments.
But even in the riskier scenario, there is still a limit to the risk that you want exposure to. If you buy shares in only one company—let’s say Coinbase—then that’s not good. If law enforcement investigates them for insider trading, there’s a good chance that the stock will take a hit.
Now let’s say you’re invested in Robinhood stock as well, which sells many of the crypto assets that Coinbase sells but not facing an investigation. Even though Coinbase takes a hit, you were protected because you also had money invested in Robinhood.
The above theme is the core idea behind Modern Portfolio Theory (MPT) which sounds complicated, but it’s not. Basically, the greater the variety of companies that exist in your portfolio, the more you can eliminate diversifiable or nonsystematic risk.
But what is systematic/systemic risk?
It’s the risk that you just can’t diversify away. It’s unrelated to any company. It’s recessions, natural disasters, and geopolitical conflicts—it’s the risk inherent to the entire market or segment.
Some risk can be reduced though, and that’s through diversifying. The above graph illustrates that as you create a portfolio with a variety of equities, you decrease nonsystematic risk, and you are left with just the systematic risk.
Private companies, like the ones we offer on Linqto, generally have a higher cost of equity than public companies. Cost of equity refers to the compensation the financial markets require in order to own the asset and take on the risk of ownership.
Therefore, the risk tends to be greater for investing in private companies, but there’s a higher expected rate of return.
This leaves private company investors with no choice but to become more aggressive with their diversification strategy. It’s in part why you’ll see venture funds have webpages—seemingly a mile long—filled with logos of companies they’ve invested in.
If you are a private company investor and have only invested in one or two companies, then ask yourself—will you realize the higher returns of private equity if you’re not diversified in your private company portfolio?
As with any investing strategy, diversification is paramount. We are fortunate enough to bring exposure to private markets to you—but invest wisely and diversify.