In the last module, we learned how much Investment Capital should be allocated overall & why diversification is necessary to achieve sizable profits while minimizing risks.

In this module, we’ll do a comprehensive study of the Power of the Law of Returns & find ways of how to win big without losing money. Like always, we’ll try to understand this topic through a story:

Joe was a savvy investor with a knack for picking promising ventures. Over the years, he meticulously built a diverse portfolio, investing in 20 companies that spanned the spectrum from small cap to large cap. Joe's strategy was simple yet effective: diversify to mitigate risk and maximize potential gains.

Despite his varied investments, Joe understood the Law of Returns. This principle asserts that the returns of 25% of your investments will determine your overall return, while the rest will yield either average or suboptimal results. Joe's portfolio was no exception. Out of the 20 companies, five stood out, delivering exceptional returns that bolstered his overall performance. The remaining 15 companies produced modest or disappointing results, underscoring the importance of the top performers.

The pattern was clear: few investments often drove most gains. Joe's experience reinforced this concept, illustrating that in the world of investing, a few stellar performers could significantly influence the overall success of a portfolio.

We will further validate this theory later in the article when we apply it to returns generated by an experienced Angel Investor.

Many aspiring investors would possibly be hearing the term “Law of Returns” for the first time in their lives. The questions that might bother them would be, First, What is the Law of Returns & Second, How to identify high potential opportunities that would help maximize the Law of Returns?

Let’s start with the first question ~ What is the Law of Returns?

The Law of Returns for Angel Investors mirrors the economic principle of diminishing returns. Initially, as angel investors diversify their investments, returns may surge, benefitting from a broad portfolio. However, beyond a certain point, spreading investments too thin can lead to diminishing returns.

In essence, The Law of Returns states that a handful of investments drive the bulk of the returns. A few successful investments can recoup the losses of many unsuccessful investments.

In other words, Strategic, well-informed investments remain crucial to achieving optimal returns in the dynamic startup funding landscape.

Let’s take an example to understand the Law of Returns. Take a case where an investor has 100 companies in front of him and he chooses to invest ₹10 Lakhs in each one of them. Out of the 100 companies, only 10 companies will be those who give over 5x returns, even out of these 10, only 2-3 would generate superstar returns of upto 50x & beyond.

Out of the remaining 90 companies, 30 companies will be those who give average returns, ranging between 1x & 5x & 60 companies will be those who give sub-optimal returns of less than even 1x.

Overall, the returns generated on invested income would be estimated to be around 21.3%, at CAGR, over 7 years.

Category	Category Return	Company Return Assumption	Invested Capital	Total Return	Time Frame
Cat - A	>50x	70x	2	140	7
Cat-B	10x - 50x	30x	3	90
Cat - C	5x - 10x	7x	5	35
Cat - D	1x - 5x	3x	30	90
Cat - E	<1x	0.7x	45	31.5
Cat - F	0x	0x	15	0
			100	368.5	21.3%

Let’s now understand the Law of Returns with the help of an example. For instance, we shall look at the asset allocation of Anupam Mittal, Founder & CEO of Shaadi.com. I am sure all of you would have seen the popular reality show Shark Tank India. Anupam Mittal is a Shark in that show who invests in budding startups with high growth potential. Now that we are done with the introduction part, let's shift our focus towards his Asset allocation.

Category	Category Return	Company Return Assumption	Invested Capital	Total Return	Time Frame
Cat - A	>50x	3 >100x (1>150x)	2	140	5
Cat-B	10x - 50x	10
Cat - C	5x - 10x	15
Cat - D	1x - 5x	40
Cat - E	<1x	4
Cat - F	0x	38
Total	118 companies	110		IRR 40%

Now what we can infer from the portfolio allocation table of Anupam Mittal is that there will 25%-30% of such investments out of our total investable companies will give us returns of more than 5x & whereas another 50% of the remaining 75% will generate returns between 1x-5x & last 25-30% will like to give us no returns or even might erode our capital. The below picture of a bell curve will further help add to investors’ clarity about how much returns to expect from their portfolio allocation.

The reference to these data points can be credited to the book titled ‘Insider Secrets to Wealth Creation’ by Sanjay Kulkarni.

It is to be noted that no investment is without a risk. Although, by taking time to understand both the business and your investment goals you can help mitigate some of those risks and give yourself a better chance at earning a healthy return on an investment.