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> Invest in a startup. This is better than investing in the S&P500. The expected return is higher. Is that actually true, or is the author using some meaning o

by davidmr 11y ago

> Invest in a startup. This is better than investing in the S&P500. The expected return is higher. Is that actually true, or is the author using some meaning of the phrase "expected return" that isn't common?

tptacek 11y ago
My understanding is that it isn't even true for professional startup investors, and they have preferential access to dealflow that your $20,000 doesn't.
- tempestn 11y ago
  The median return is certainly lower, but the expected return at least should be higher. So most startup investments, and probably most startup investors will fail, but some will succeed spectacularly. The point is, if everyone who is interested in investing to eventually donate did so by investing in startups, their aggregate returns should be higher than if they invested in the S&P or whatever instead - so it's superior even if most of them end up with a negative return. (As opposed to when you're investing to fund your own retirement, in which case you don't so much care how others' investments go.)
  - tptacek 11y ago
    My understanding is that the median fund underperforms the S&P, and that investment managers at pension funds and endowments put money into VC funds because their strategies require them to put a slice of money into that asset class. And, again: that's the outcome for investors that have preferred access to dealflow.
    - tempestn 11y ago
      I don't have evidence to back up my assertion - only the theory that in an efficient market riskier assets should be priced appropriately. So I don't know for a fact that the expected return is higher. That said, the fact that the median fund underperforms the S&P doesn't necessarily prove that the expected return on an individual startup investment will do so. For one thing, funds will have overhead - probably significant overhead in startup investing. (Of course, they provide valuable diversification, but as mentioned above, that shouldn't be the priority in this particular case.) Also, even if the median fund underforms before costs, the average might still outperform, if the winners are relatively concentrated.
      - notahacker 11y ago
        The application of the EMH to a market as overhyped, information-poor and illiquid a market as startup investment is questionable. And another consequence of competitive markets is that funds with board seats, insider information and ability to negotiate preferential terms based on expected follow-on investment take on less risk than you when investing, but they shape the market prices for the asset. $20k is friends & family or crowdfunding money, and I suspect that whilst there will be some winners, the median return on those asset classes will be -100%
        tempestn 11y ago
        All good points. And I agree that the median return will likely be -100%. Honestly I think you're probably right that even the average return will probably be underwhelming, even if theoretically it shouldn't be. I am curious though. I certainly wouldn't invest my money in startups on the theory that on average I would end up with more to donate, even if I intended to donate 100% of the proceeds regardless...
deleted 11y ago
[deleted]
BenjaminTodd 11y ago
My reasoning is that if you accept something like the efficient market hypothesis, investing in startups is higher risk than investing in the S&P500, so the return should be higher. You could also just buy the S&P500 with leverage. I've also seen some empirical evidence in support, though I haven't vetted it: http://sites.kauffman.org/pdf/angel_groups_111207.pdf http://sites.kauffman.org/pdf/angel_groups_111207.pdf

by davidmr 11y ago

tptacek 11y ago

My understanding is that it isn't even true for professional startup investors, and they have preferential access to dealflow that your $20,000 doesn't.

tempestn 11y ago
The median return is certainly lower, but the expected return at least should be higher. So most startup investments, and probably most startup investors will fail, but some will succeed spectacularly. The point is, if everyone who is interested in investing to eventually donate did so by investing in startups, their aggregate returns should be higher than if they invested in the S&P or whatever instead - so it's superior even if most of them end up with a negative return. (As opposed to when you're investing to fund your own retirement, in which case you don't so much care how others' investments go.)
- tptacek 11y ago
  My understanding is that the median fund underperforms the S&P, and that investment managers at pension funds and endowments put money into VC funds because their strategies require them to put a slice of money into that asset class. And, again: that's the outcome for investors that have preferred access to dealflow.
  - tempestn 11y ago
    I don't have evidence to back up my assertion - only the theory that in an efficient market riskier assets should be priced appropriately. So I don't know for a fact that the expected return is higher. That said, the fact that the median fund underperforms the S&P doesn't necessarily prove that the expected return on an individual startup investment will do so. For one thing, funds will have overhead - probably significant overhead in startup investing. (Of course, they provide valuable diversification, but as mentioned above, that shouldn't be the priority in this particular case.) Also, even if the median fund underforms before costs, the average might still outperform, if the winners are relatively concentrated.
    - notahacker 11y ago
      The application of the EMH to a market as overhyped, information-poor and illiquid a market as startup investment is questionable. And another consequence of competitive markets is that funds with board seats, insider information and ability to negotiate preferential terms based on expected follow-on investment take on less risk than you when investing, but they shape the market prices for the asset. $20k is friends & family or crowdfunding money, and I suspect that whilst there will be some winners, the median return on those asset classes will be -100%
      - tempestn 11y ago
        All good points. And I agree that the median return will likely be -100%. Honestly I think you're probably right that even the average return will probably be underwhelming, even if theoretically it shouldn't be. I am curious though. I certainly wouldn't invest my money in startups on the theory that on average I would end up with more to donate, even if I intended to donate 100% of the proceeds regardless...

deleted 11y ago

[deleted]

BenjaminTodd 11y ago

My reasoning is that if you accept something like the efficient market hypothesis, investing in startups is higher risk than investing in the S&P500, so the return should be higher. You could also just buy the S&P500 with leverage. I've also seen some empirical evidence in support, though I haven't vetted it: http://sites.kauffman.org/pdf/angel_groups_111207.pdf http://sites.kauffman.org/pdf/angel_groups_111207.pdf