Public Investing for Startup Employees
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TL;DR: Private market companies, like startups, have grown faster than public market companies over the last few decades. Tech workers trying to grow their wealth might invest more capital in private market investments like startup equity rather than public investments like stocks and bonds. This comes at the cost of illiquidity, concentrated risk, and binary outcomes. For investors who want to diversify their investments, manage risk, stay liquid, and still grow, public market stocks and bonds may still play a substantial role. Tech employees should build public market portfolios that take into account their unique financial profiles.
Why invest in public markets
Given Tech Employees’ access to private market investments—like startup equity—there are six reasons why tech employees might choose to allocate capital to public investments:
- I want to generate stable returns so I can be more confident in my investment outcomes. I don’t want to take the most risk possible.
- I don’t have private investment opportunities I feel confident about, but I still want to growth my wealth.
- I am highly concentrated in tech investments, and I want to de-risk my portfolio by investing in other sectors or asset classes, so that if technology underperforms I can still sustain growth.
- I have already had a successful exit and I want to keep growing my wealth by making investments with more stable, predictable returns. I know that most of the time post-IPO stocks perform worse than diversified holdings.
- I need liquidity in the next few years to fund a specific event like a home purchase, major investments, or unexpected expenses. I want to make investments that I can sell when the time is right.
- I want to invest in assets that I can borrow against, if I ever need a loan in the future.
Tech employees’ finances are unique
The average American pulls two levers to generate wealth: they earn a salary, and they invest portions of their salary in public markets in order to grow their wealth over time. Tech employees have more levers. They can invest in private companies—companies that haven’t yet had an initial public offering or been acquired by publicly traded companies. You may not think of it this way, but equity compensation (like startup options) is the main way tech employees invest in private markets, especially early in their careers. Angel investments, special purpose vehicles, and investment funds are other common tools.
The ability to invest in private markets is a unique advantage versus a typical investor, whose access to private markets is low and whose knowledge of private markets is often even lower. Private market investments tend to generate higher growth than public market investments. Venture capital and private equity fund returns—which are a rough proxy for the performance of private market companies—are generally higher than public market returns.
But private markets have their own unique sets of risks. Investing in private companies, like through startup option exercising, means owning an illiquid security—it can be difficult to sell your position before an exit event. After exercising startup options or writing an angel check for an early-stage company, it could be 10+ years before the investment can be sold.
And, while there is lots of information widely available about public companies, it can be hard to learn about private companies. This creates information asymmetry, where some private market investors know much more than others. The asymmetry results in return dispersion: great investments can generate massive returns, but poor ones can “go to zero”.
It’s common for a tech employee’s net worth to be overwhelmingly made up of equity from one or more technology companies. A large, concentrated position in private technology companies means that an individual’s financial outcomes are more binary: if tech does well or my company does well, growth is very high; if tech performs poorly or my company doesn’t thrive, the entire portfolio is dragged down.
How tech employees should look at their public market portfolios
For your typical American, a diversified investment in public markets may be the highest-growth opportunity they have access to. So, those looking to maximize long-term wealth might choose to allocate a significant portion of their liquid assets to public markets.
But for tech employees optimizing for wealth creation, this may not be the case. If an individual has…
- Access to private market investments
- High accuracy in choosing opportunities that deliver strong growth
- Tolerance for long periods of illiquidity
- Comfort with more ‘binary’ risk, where investments could grow or decline precipitously
…then public market investing is not necessarily the best way to generate wealth. Instead, public market investments are tools to complement private market investments, and deliver more certain outcomes.
What tech employees’ public investments should look like
For anyone investing in public markets, passive investing is often the best approach. When investors do seek to generate alpha through active investing, they tend to underperform passive strategies over the long term. Between 2011 to 2021, only 17.5% of active managers outperformed the S&P 500 index. And when it comes to individual investors, common behaviors —like trend following, poor diversification, or overly-concentrated bets—result in worse performance than if investors had bought-and-held ETFs.
For passive investors building a public market portfolio, there are two primary focuses:
- Selecting assets that are likely to produce the desired balance of growth and volatility.
- Making sure that the portfolio is constructed optimally so that you’re not taking on more risk than necessary to generate the desired return.
These principles are the core of modern thinking on portfolio design. But, based on where an investor works and the other assets they hold, an optimal public market portfolio might look different.
What makes tech employees’ public investments different
Consider a hypothetical 30-year-old employee at an early-stage tech company. Their job security is linked to the US tech sector, as is the value of their company equity—which makes up the majority of their net worth. They are young and want to prioritize strong long-term returns.
If they want to invest in public markets, the question isn’t “which ETF should I invest in?” as there are plenty of options, many of which offer similar benefits. But their profile as a tech employee makes their portfolio design decisions complex and calls for a specific approach to investing. Here are a few tech-specific considerations:
- Large cap stocks – Ordinarily, an investor looking for growth might invest heavily in large US companies—but large US companies are largely tech companies. For a tech employee, too much more exposure to tech may be an inefficient way to allocate capital.
- High growth stocks – Many investors looking for returns would focus exclusively on high-growth, volatile assets. But for a tech employee whose net worth is largely made up of illiquid equity, it might be beneficial to include other assets, like bonds, that are more stable and are less correlated to equity markets. These can be sold when liquidity is needed.
- Capital gains – Few investors have to worry about capital gain events. But for tech employees, startup exits are very large capital gain events which call for tax-conscious investing. Tax-loss harvesting can have outsized benefits for tech employees looking to offset capital gains.
These considerations mean that tech employees are often best off investing in a portfolio that seeks US LargeCap exposure that de-emphasizes the tech sector, and includes inflation-resistant assets. The portfolio should prioritize tax-loss harvesting in hopes of offsetting capital gains. And the portfolio could include a small sleeve of fixed income securities to cover cash expenses in future years.
Ultimately, although public markets investing may play a slightly different role in a tech employee’s portfolio than the typical investor, it’s a powerful tool. Through conscientious asset allocation and portfolio design, tech employees can use public markets to keep a proper balance between growth and predictability in their investments.
If you’re interested in building an investment portfolio that takes into account your unique financial profile, Compound can help. Invest in a portfolio that is designed to be resilient in times of volatility and inflation, and that is built around your existing investments and startup equity.