What would you do with an extra million dollars in cash?
Retire tomorrow? Buy a new house? Buy a Ferrari? Put it in the bank and massively increase your financial freedom?
Sure, it’s nice to daydream about having an extra million dollars in the bank. But I’m asking you this question because it’s a real-life situation the financial backers of early-stage companies – venture capitalists – often find themselves in.
When it comes to extreme wealth creation, few endeavors can compare to being an owner of a small company that grows large.
As I mentioned in yesterday’s essay, an early investor in Microsoft could have made over 9,000% during the 1990s. That type of gain turns every $5,000 invested in $450,000.
It only takes one of these big hits to make a huge amount of money in early-stage companies. And that is why it is critical that you approach the companies we recommend in this service with a “venture capitalist” mindset.
What are venture capitalists? And how do they earn such massive returns?
Venture capitalists are the early backers of start-up companies. They are the grand slam, home run hitters of the investment world. They don’t look to make 300% on their investments. They look to make 3,000%… even 30,000% on their investments.
Make just one great venture-capital investment and you’ll probably never have to worry about money. Venture capitalists have funded nearly every mega-hit technology company you know today: Google (now Alphabet), Facebook, Twitter, Uber, Airbnb, Pinterest, and the list goes on and on.
Before the public learned about these innovative businesses, venture capitalists were there, performing due diligence and making early investments.
By the time regular stock market investors hear about your average technology winner like Google, venture capitalists have made more than 2,000% on their original investments. And while we don’t recommend non-public companies in my Early Stage Investor research service, we still very much employ a venture capital mindset.
We are looking to hit grand slam home runs. We are looking to make hundreds, even thousands of percent returns in the world’s best early-stage public companies.
Grand Slam Portfolio Management
To the average investor, a 33% “win rate” on stock buys is a depressing thought. Having a high “win rate” – like “8 out of 10 stock picks are winners” – is important to average investors.
However, the best venture capitalists and professional traders don’t place any emphasis on “win rate.” They know that with a good strategy, you can be right just 33% of the time and make a fortune in stocks.
Early-stage stocks are among the riskiest securities in the market. They are more volatile and have higher failure rates than established businesses like Walmart and Coca-Cola. That’s just the nature of the game… and that’s why the payoffs in early-stage investments can be so huge.
Because early-stage companies can produce such gigantic capital gains – and because they have higher failure rates than established businesses – it’s vital to understand a key money management principle used by the best venture capitalists.
As an early-stage investor, you’re not going to achieve success on 100% of your investments. You probably won’t achieve success 75% of the time… or 66% of the time. And that’s fine.
When you invest like a venture capitalist, you can be right just 33% of the time and still make HUGE returns.
Some simple math shows us how it works… Let’s look at a hypothetical investment example.
On December 1st, you structure a “venture capital” portfolio of 12 promising businesses. You hold them for a year. The returns of these 12 stocks are listed below:
In this example, four went up and eight went down. You were right 33% of the time. But because you hit just a few big winners, you made a great average return of 40% across the 12 positions.
Over the past 60 years, the legendary trader George Soros has made more than $20 billion in the financial markets. Soros is a genius at knowing how government actions affect markets. He’s skilled at finding industries poised to boom. But there’s a simple mindset that’s more responsible for Soros’ success than either of those things. Soros once summed it up like this:
“It’s not whether you’re right or wrong that’s important, but how much money you make when you’re right and how much you lose when you’re wrong.”
Soros didn’t focus on how often he was right. He focused on making his successes big and meaningful… and making sure his mistakes were small and manageable. That’s what we need to do as well.
I get how people feel the need to be right. I like to be right as much as anyone. In my early years as a stock broker, I had a boss once ask me, “Do you want to be right or rich?” I did not answer him, but I knew immediately what the correct answer was. I try to reduce my downside risk as much as possible. But the simple fact is that early-stage companies carry risk. I know I’m not going to be right 100% of the time.
The good news is, when you make sure to win a lot when you’re right, and only lose a little when you are wrong, you can be right just 33% or 50% of the time… and still make huge profits in early-stage companies.
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