Truly Investing vs. “Trading” Investing

Editor’s Note: Today we’re running an updated version of an article from November of last year. In it, Adam goes into the all-important difference between trading and investing. As you’ll see, those who invest make far more money on average.


Very few people truly invest these days.

Most people trade. They play the markets, looking for a quick score. All too often, they sell low and buy high.

Many of us don’t let our winning stocks run long enough. Or we hold on to losers too long.

Our emotions work against us. And it shows. According to a study by BlackRock, from 1994 to 2013 the average U.S. investor made just 2.5% a year…

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BlackRock goes on to explain the dismal returns:

Allowing your emotions to influence your investment decision-making can prove costly. In fact, the average investor’s realized returns have paled in comparison to a strategy of buying and holding a particular asset class.

Over that same time period, a strategy that bought and held U.S. stocks or bonds would have outperformed the average investor experience by 3X or 2X, respectively.

As you can see, people aren’t very good at trading. Yet that’s what most “investors” do, year after year.

When you invest in startups, trading isn’t an option. Once you put money into an early-stage company, you’re invested. It could take five to seven years for an “exit” opportunity to come up. There may be opportunities to cash out sooner, but it’s not guaranteed.

This means there’s little chance of emotion getting in the way. “Buy and hold” style discipline is enforced automatically.

It’s one of my favorite aspects of this asset class. It’s truly investing.

And it works. The chart below was put out by a firm called Cambridge Associates. It tracks private investment performance.

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Click to view larger image

As you can see, the early-stage venture capital index has returned 57% annually over the last 20 years. A truly remarkable performance that blows everything else out of the water.

Think about that for a second.

The average American investor made 2.5% a year (from 1994 to 2013).

The average early-stage private fund made…

  • 21% annually over the last 30 years
  • 30% annually over the last 25 years
  • 57% annually over the last 20 years.

It makes the “private investments were off-limits to members of the general public to ‘protect’ them” argument a little ridiculous, doesn’t it?

A Different Animal

Investing in startups minimizes one type of emotional risk: buying or selling at the wrong time.

But there’s another type of emotion that can cloud our decision-making here: excitement.

Early-stage investing can be downright thrilling at times. Companies are young, full of hope and ambition. Ready to take on the world.

Investor pitch decks are full of big exciting numbers. “A $10 billion market just waiting to be disrupted!”

So it’s important to remember that many startups fail. That’s the nature of the beast. It’s why you need a portfolio of at least 10, and preferably 20 or more investments. If you do it right, the winners will more than make up for the duds.

Don’t get me wrong. You’d be hard-pressed to find someone more bullish on tech startups than me. There are plenty of great companies out there raising money today.

And we’re still at the beginning of the internet revolution (historically speaking). The cost to start a tech company has plummeted over the last decade, thanks to growth in open source (free) software, along with other developments in tech.

Breakthroughs in marketing tech, such as Google’s AdWords program, have made it far easier to target potential customers directly. Today you can advertise to people who search for a certain keyword, are in a certain demographic or visit specific websites. This means that scaling up a business using advertising is an order of magnitude easier than it used to be.

It’s a fantastic time to be an early-stage investor. Never been better.

But it can be easy to get overly excited about opportunities. Thanks to sites like AngelList, Wefunder, FundersClub, OurCrowd, MicroVentures, Crowdfunder, SeedInvest and Republic, we can see dozens of deals per day.

On top of all this, now everyone in America can invest in privately held startup companies.

It’s an exciting time.

But I urge new investors to take it slow. At first, every deal may look like a winner. Spoiler alert: They can’t all be winners…

When evaluating a deal, I run through a mental checklist. Here’s a simplified version of what it looks like.

  • Progress-per-dollar: How much money has the company raised, and how much has it accomplished with that money?
  • Co-investors: Who else is investing? How is their track record and reputation?
  • Founders: What’s their background? Is this an industry they know well and are passionate about?
  • Growth: Does the company have a clear growth path? If it’s not explained clearly in the pitch deck, ask the founders.
  • Traction: How are sales and/or user growth? Are they sustainable?
  • Customers: Whenever possible, try to get a read on how much attention a company is paying to its customers (the more the better). Ask the founders.
  • Burn rate: How much cash is it burning per month? What’s its “runway” with current capital?
  • Market: How big is the company’s real addressable market? How much could it realistically grab?

And as I’ve said before, don’t fall in love with an idea. The idea itself means far less than the execution to date.

Have questions or comments? Let us know in the comments section. Just remember, keep the questions general. We can’t answer questions about your personal financial situation.

Good investing,

Adam Sharp
Founder, Early Investing

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