4 months ago • 4:31 mins
Bitcoin has already pulled back around 12% in April, falling to just over $40,000. And according to billionaire co-founder of crypto trading platform BitMEX Arthur Hayes, that might be the calm before the storm: he reckons a tech rout could send its price to $30,000 by June. So let’s look at the four things you can do to batten down the hatches, while keeping your portfolio on track to sail off into the sunset.
Harry Markowitz said that “diversification is the only free lunch” in investing, and that’s just as true of crypto.
There are two ways to diversify your digital portfolio. First, you can diversify between different cryptoassets by holding five to 10 that pique your interest. That way, your overall returns will depend less on the performance of a single investment. This lets you minimize your downside risk, and may actually make for higher returns over time: by spreading your bets, you’ll have a far better chance of finding that needle in the crypto haystack.
Second, you can diversify between different asset classes, like gold, stocks and bonds. That’ll help you manage the worst-case peak-to-trough fall for your portfolio.
The chart below, for instance, plots the bitcoin price (blue line) vs. gold (um, gold line) over the past two years. Notice how they’ve tended to move in opposite directions. And if you look at the circles, you can see how owning some gold would have helped protect your portfolio during the last two major bitcoin slides.
Of course, relationships between asset classes shift all the time, so it’s best to hold a range of different investments – not just gold – alongside your crypto portfolio.
Crypto is so much more volatile than other assets that you’ll need to set a crypto allocation that suits your risk tolerance.
Begin by deciding how much of your overall investable wealth to allocate to crypto. There are two things to consider here. The first is your ability to take risks – that is, how much you can afford to take. This will be higher if you have a steady income that comfortably covers your living expenses, a longer investment horizon, emergency cash reserves, and little or no debt.
The second is your willingness to take risks – that is, how comfortable you are with daily swings in your unrealized net worth. This is a personal choice that only you can make, but if you’re unsure, ask yourself which of the following you’d feel more keenly: the feeling when you lose half your investment, or the feeling when you double it. Your answer will help you determine whether you prefer taking more risks (i.e. holding more crypto) or playing it safe (holding less).
Once you’ve decided how much of your investable wealth to allocate toward crypto, you’ll need to choose how that balance is split between different coins. That too will depend on your risk tolerance. Bitcoin is usually less volatile than “altcoins” (other digital assets), so if you’re looking to take less risk, consider holding more in bitcoin and less in altcoins. Also assess the market size of your digital picks – you’ll want higher weights in blue chip digital assets like Ethereum and lower weights in more speculative small cap tokens.
Make a note of your preferred crypto allocation: you’ll need to rebalance every so often to make sure it doesn’t drift too far from your target range.
Let’s say you’ve chosen to put 5% of your investable wealth into crypto, and three months later, that’s drifted to 10% because crypto has outperformed your other investments. By rebalancing back to 5% (i.e. selling some crypto to top up the percentages in other classes), you’ll bank some of those gains and lower the risk of a larger portfolio fall. On the flipside, if crypto underperforms and that 5% becomes 2.5%, you can top up by buying cheaper coins. You can also apply the same logic within your crypto portfolio to get to your target mix of coins.
Dollar-cost averaging (DCA) will go a long way toward squashing the volatility of your crypto portfolio: it means you invest small sums bit by bit, allowing you to buy in at a more reasonable price over time. And in some cases, it can actually improve the return of your investment as well.
The chart below shows two scenarios. One where you invested $1,200 in bitcoin on April 1st last year, and another where you invested $100 per month for 12 straight months. Since the price of bitcoin dropped (from around $59,000 to $46,000) over that time, you’d be down about 22% on the lump-sum investment. But with DCA, you’d be a lot better off – up 0.6% overall at the end of the 12-month period.
If you get a great entry price, a lump-sum investment can certainly outperform DCA in a strong bull run. But more often than not, crypto markets range up and down, so it’s safer to ladder your buys over different periods.
Managing your crypto portfolio risks may not always lead to massive gains in up markets, but it will help protect you from major losses during drop-offs.
Remember that if you lose half of your investment, you need to double it to get back to where you started – and this problem becomes exponentially worse as losses grow larger. By managing your crypto risks, you’ll reduce the swings of your portfolio value while still having enough skin in the game to be rewarded in the long run – and you’ll probably sleep better too.
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