The Power of Indexing: Stop Trying to Pick Winners

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The Power of Indexing: Stop Trying to Pick Winners

Startup investing is a game of home runs and strikeouts. But if you're trying to pick the next unicorn by backing just a handful of startups, you're thinking about it all wrong. The truth is, most investors, even professional VCs, can’t predict which startups will deliver outsized returns. Instead of chasing the illusion of certainty, smart investors turn to indexing - a strategy designed to maximize exposure to outlier successes while minimizing downside risk.

You’re Not as Good at Picking Winners as You Think

Let’s be honest, everyone wants to be the investor who backed Uber at seed stage or recognised Airbnb’s potential before anyone else. But the reality of startup investing is that even the best VCs get it wrong a lot of the time. Power law dynamics rule venture capital, meaning only a tiny percentage of investments generate nearly all the returns (AngelList Study).

A single deal that 100x’s can offset dozens of failures, but miss that one, and your portfolio might end up underwater. And here’s the kicker: you can’t know in advance which startup will be your 100x return. Even seasoned investors miss out on legendary companies. Many VCs famously passed on Airbnb at the seed stage. They had all the data, all the connections, and still got it wrong (Tyler Tringas on Indexing).

The Math Behind Indexing: More Shots, Better Odds

So, what’s the smarter approach you ask? Indexing - investing across a broad number of startups to increase the likelihood of catching one of these outliers. AngelList data shows that as portfolio size grows, the risk of losing money decreases, and the odds of a 3x+ return increase dramatically (AngelList Data). A portfolio of just 10 startups is dangerously concentrated. A portfolio of 50+ startups? Now you’re playing the real venture game.

Indexing works because of two simple rules:

1. The more investments you make, the higher your probability of hitting an outlier.

2. A single outlier can generate returns large enough to make up for all the losses.

Think of it like baseball - the Babe Ruth Effect. The best home run hitters also strike out the most (Babe Ruth Effect). But when they connect, they hit it out of the park. In startup investing, indexing ensures you’re always in the game.

The Power Law and Why You Need Exposure to Everything

VC is not about hitting a high batting average; it’s about magnitude over frequency (Power Law). If your portfolio is too small, you’re not giving yourself enough chances to hit the big one. That’s why top-tier VCs invest in dozens, if not hundreds, of startups per fund.

Based on some research from Steve Crossan (Ideas for angel investors), you should probably aim to have at least 150 deals in your startup portfolio, but more like 300 if you can. If you have a 300 deal portfolio instead of a 30 deal portfolio, your chance of tripling or quintupling your money is ~80% higher:

Perhaps more surprisingly, your chance of 10xing your money doesn’t decrease. The upside of a true outlier outweighs the downside risk of losing money on all the others. 

Now, we appreciate how difficult it is to build a 300+ strong startup portfolio but you’ll be happy to know that as your portfolio grows even beyond 30 companies, the chance of losing money altogether declines from as high as 10% to close to 0!

Timing Also Matters: The ‘Time Machine’ Approach

Not only do you need breadth, but you also need time diversification - investing across different market conditions (Time Machine Investing). If you only invest during a frothy market, you’ll pay inflated valuations. If you only invest during downturns, you might miss out on big growth periods. The best strategy? Investing consistently over time. This approach, sometimes called the ‘time machine strategy’, ensures you get exposure to different market cycles, reducing risk and increasing your odds of landing a breakout success.

But What About Due Diligence?

Skeptics of indexing argue that “spraying and praying” is reckless. But indexing isn’t about blindly throwing money at bad deals, it’s about systematically investing in credible opportunities.

The key here is access! Investing in every credible early-stage deal you can (rather than just the few you personally like) increases your exposure to potential winners. Due diligence still matters, but it should be about filtering out bad deals, not trying to cherry-pick the next unicorn.

Retail Investors Finally Have a Seat at the Table

Historically, startup investing was reserved for the ultra-wealthy. But that’s changing. Platforms like AngelList, Odin, and Shuttle are democratising access to early-stage investing. More investors can now apply indexing principles to startup investing, just like they would with ETFs in public markets.

Final Thought: Play the Game the Right Way

If you want to be a serious startup investor, forget about “picking winners.” Instead, build a diversified portfolio, spread investments over time, and focus on getting exposure to as many quality opportunities as possible. The power law will do the rest.

As the old saying goes, “You miss 100% of the shots you don’t take.” In startup investing, the key is making sure you take enough shots!

What we’ve been working on at Shuttle

• Speaking with new customers and learning how we can improve 🛠️

• Working towards a successful close for launch No.2 🚀

• Added an updates section to investor portfolios 📰

• Sourcing more great deals for our community 🤝

The Unsophisticated Investor is brought to you by Scott & Rob, the founders of Shuttle. We’re both sick of private markets being a playground exclusive to the ultra-wealthy so we started a company to challenge the status-quo. Shuttle’s singular focus is to unlock private markets for Millennial and Gen Z retail investors and help them build wealth through the highest performing private market opportunities.

Scott & Rob
Shuttle Co-Founders