Power-law distribution

An outcome pattern in which a very small number of results account for most of the total, rather than results clustering around an average.

Example

In a set of twenty early-stage investments, one outcome producing $100,000 of $175,000 in total proceeds.

Important

Where this pattern holds, the portfolio's result is decided by whether it contained the rare outcome at all - which makes the number of positions a first-order decision rather than a detail.

Related terms

• Position size — How much of your total capital a single holding represents - the weight that decides how much any given move actually matters to you.
• Expected value — The average outcome of a decision if you could repeat it many times: each possible result multiplied by its probability, all added together.
• Diversification — Holding enough genuinely different assets that no single outcome decides your result. It reduces risk specific to individual holdings; it does not reduce the risk they all share.

Lessons that explain it

• One investment can decide the return of twenty — Venture portfolio returns follow a power law: most of the money comes from very few companies. Working through a portfolio's arithmetic shows why missing the best company matters more than avoiding the worst. (11 min)
• Acquisition, listing, secondary sale or wind-down - most exits are the first and the last — Private investments return money through a sale of the company, a public listing, selling shares to another investor, or a wind-down. Public listings are the most visible and among the least common outcomes. (9 min)
• Adding to winners at higher prices often beats rescuing losers at lower ones — Follow-on capital usually has a better expected result in companies with strong evidence, even at higher prices, than in struggling companies at lower prices - though the right choice always depends on the specific evidence. (11 min)
• The same company can be a good investment at one price and a bad one at another — An investment decision weighs the range of outcomes against the price paid. Scenario-based expected value shows how quickly a higher price erodes the return from the same company. (11 min)
• Size each investment for the likely loss, not the hoped-for win — Once an investment is attractive, the remaining decision is how much. Position size should reflect the probability of losing everything, the portfolio you plan to build and what you can afford to lose. (10 min)
• Position sizing: how much of it to own — Sizing is where conviction gets converted into consequences, and it is the one variable in investing that is entirely within your control. Most people set it by feel and discover afterwards what they actually decided. (12 min)

All 578 terms in the Investing glossary