Equity Crowdfunding versus Stock Investing?
Equity crowdfunding offers higher returns on investment but how does it stack up on other factors versus stock investing?
So maybe I’m a little biased to equity crowdfunding. As a venture capital analyst, I’ve seen the huge returns in startup investing compared to stock investing and I’m excited about the new asset class for regular investors.
But should most investors even care about investing in the crowd?
Equity crowdfunding returns are well into the double-digits and may be the next big thing but that doesn’t mean there aren’t massive risks as well. Do most investors even need the higher return on investment or can you meet your investing goals with stocks and bonds?
How do you decide how much to invest in equity crowdfunding deals or should you just stick to investing in the stock market?
Let’s compare equity crowdfunding versus stock investing in four key themes to help answer the questions.
What are Equity Crowdfunding and Stock Investing?
Equity crowdfunding is an alternative to a traditional publicly traded company where anyone can invest their money to support startup businesses and earn returns on investment (ROI). You buy shares of the business you want to support; so, if they succeed, your investment will pay off.
Stock investing, on the other hand, means purchasing ownership in companies in exchange for cash now. Most people purchase stocks that represent a part of a publically-traded company because it offers liquidity – the ability to convert your ownership into cash at any time by selling it on the stock market.
These two types of investment differ in many ways and work best with different kinds of investors. Here are the main distinctions between equity crowdfunding and stock investing, starting with the most basic.
Equity Crowdfunding versus Stock Investing: Returns
Returns on stocks in the S&P 500 have averaged 8% annually over the last 20 years. That’s pretty good considering two monstrous stock market crashes during the period.
That annual gain pales in comparison to the average for a portfolio of startup investments, with research on angel investing by Willamette University showing gains of about 25% annually. While most of your equity crowdfunding investments will likely bust or return less than your original investment, the stars could end up returning 20- and 30-times your money.
Even crowdfunding returns on safer real estate assets have ranged from 7% to as high as 19% across debt and equity. RealtyShares offers both debt and equity investments in properties. Investors can invest as little as $2,000 in individual deals for a share of the monthly cash flows.
I follow several crowdfunding platforms to get access to as many deals as possible. It costs nothing extra to have an account on more than one crowdfunding site and you’ll be able to invest in more deals.
Research points to the need for at least 20 crowdfunding deals to balance out and achieve this average crowdfunding return so don’t expect to strike it rich on every one of your investments. While there are stock funds that you can buy for equity market diversification, they don’t yet exist for crowdfunding so you’ll need to pick your own winners.
Advantage: Equity Crowdfunding
Equity Crowdfunding versus Stock Investing: Risk
As mentioned, more than half of your crowdfunding deals in startup companies will probably go south. All early-stage deals are risky and it’s not likely you’ll be able to pick out the ones most likely to fail ahead of time.
Stock investing can be risky as well, especially investment in penny stocks and companies with very high levels of debt. For the most part, it’s much more obvious which stocks carry the most risk and face the potential for total loss.
For more established companies, the risk is much lower. Less than 5% of the stocks in the S&P 500 are dropped from the index each year and most of this is from mergers and acquisitions. Only a percent or less usually go bankrupt or fall into major financial problems.
The risk in equity crowdfunding is compounded by the size of the investment. While you may be able to buy many stocks for a few hundred dollars, most investments in start-ups are for much larger sums. If your entire crowdfunding return will depend on a few investments, you want to be able to make enough on them to make it worth it.
This means each crowdfunding investment may be as much as $500 or more, making the failed deals hurt all the more painfully.
Advantage: Stock Investing
Note though that not all types of crowdfunding investing are equally risky. Real estate crowdfunding may not enjoy the return on investment you’ll see in startups but it’s also much lower risk. Each deal is backed by property with stable cash flow and the future outlook is generally much easier to forecast.
Equity Crowdfunding versus Stock Investing: Time Commitment
Don’t expect to trade in and out of crowdfunding investments like you can with stocks. In fact, regulations require that investors hold their shares for at least a year.
There’s evidence to suggest that crowdfunding investments may pay out earlier than traditional angel investing or venture capital but it will still take at least several years to make any money.
The traditional early-stage investing model, the five-in and five-out model, is to raise money for a fund and invest in companies for five years before seeing your investments pay out over the following five years.
That’s ten years before you start seeing the average returns on a portfolio of crowd investments. Worse is the fact that your losers are going to be relatively quick to fold in the first few years, making your portfolio returns look horrendous until you start seeing the bigger payouts from successful investments.
Time before you see a return on investment for crowdfunding:
- Equity crowdfunding – 3 to 5 years
- Debt crowdfunding – 3 to 5 years
- Equity real estate – 1 to 3 years
- Debt real estate – monthly cash flow within 6 months
You can trade in and out of stocks in less than a minute. Some high frequency trading firms may even hold a stock investment for less than a fraction of a second. Buying and selling your stocks in less than a year is the worst kind of investing and costs mountains of fees but the opportunity is there.
Another difference here is the time commitment it will probably take to analyze crowdfunding investments versus stock investing. Since relatively little is known about early-stage companies, you’ll have to do much more of the research work yourself.
As a venture capital analyst, I would spend weeks on necessary research, talking with management and developing a valuation for a company. By comparison, even detailed research into a publicly-traded company will take a week or less.
I put nearly a decade of startup investing in Investing in the Next Big Thing. Through the 15 chapters, the book walks you through everything you need to understand crowdfunding investing, find and analyze the best deals, and how to strategically place your investments to avoid dilution.
Investing in the Next Big Thing is a real-world look at how I’ve picked startup investments for institutional investors including a case study on what could be the next social media giant.
Advantage: Stock Investing
Equity Crowdfunding versus Stock Investing: Fees
Fees are one of the biggest problems for stock investors. Even the discount online investing sites can get expensive if you’re trading in-and-out of stocks quickly. A Fidelity survey found the average investor makes almost 80 trades a year.
That’s $400 in fees even on the cheapest broker sites. That’s a fee of 2% on a $20,000 portfolio and before you add in any management fees on funds or other platform fees.
Investing fees in equity crowdfunding are comparatively low. Only a few platforms are charging any kind of an investor fee for membership or processing. You could pay more if you decide to hire out any of the deal analysis but most fees are paid by the startup.
Advantage: Equity Crowdfunding
Equity Crowdfunding versus Stocks or Both
While there are advantages on both sides for equity crowdfunding and stock investing, the decision isn’t really to choose one or the other.
Both stocks and equity crowdfunding investments can be a part of a balanced portfolio. Stocks provide relative safety, consistent income from dividends and much more liquidity. Equity crowdfunding offers the potential for higher returns at a relatively lower cost in fees.
Both equity crowdfunding and stocks will be susceptible to risks in the overall economy so you’ll also want to invest in bonds, peer lending and real estate to truly diversify your wealth.
Equity crowdfunding is emerging as an excellent asset class with a high return on investment for regular investors but you should balance the risks with other assets like stock investing. Understand how to change your investments by age according to your own risk tolerance and need for return. Put it all together and you’ll be able to meet your investing goals with as little risk possible.
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