A constant theme that you hear in the traditional investing world is to diversify your investments. There are pros and cons to this approach for those who invest in stocks and bonds. The usual rational for diversification is that by doing so you are spreading your risk across several investments. For some investors, the best way to diversify is to use an exchange traded fund that does the diversification for you. Should you diversify your crypto investments and, if so, how would you go about doing that?
How Can You Diversify a Portfolio?
In the world of traditional finance, diversification means investing in a mixture of stocks and bonds. Stocks provide the chance of better profits while bonds provide relative safety. Bonds can be seen as cash equivalents or the same as just holding onto cash. In the world of crypto you have traditional crypto tokens like Bitcoin and you have stablecoins. Stablecoins are the cash equivalent part while Bitcoin is like buying a stock like Apple or Amazon.com.
High and Low Risk Cryptocurrencies
In the world of stocks, there are new companies that have the potential for significant growth and there are companies like Coca Cola that are stable and pay a decent dividend decade after decade. In the world of cryptocurrencies there are established tokens like Bitcoin, Ether, and Cardano. They go up and down but are unlikely to fall off the earth or multiply greatly in value. And there are new tokens with the potential for significant growth before they settle in. Techopedia lists seven high-risk cryptocurrencies with growth potential. These include Bitcoin Minetrix (BTCMTX), Launchpad XYZ (LPX), yPredict (YPRED), eTukTuk (TUK), Chimpzee (CHMPZ), Scorp Token (SCORP), and Wall Street Memes (WSM). Each of these is essentially a “story” investment. The vast majority of new cryptocurrencies fold and investors lose all of their money. When someone invests in the right one by good insight or by chance, they can earn multiples of their initial investment. Many investors allocate a small portion of their portfolio to these kinds of investments while keeping the rest in investments that are more secure.
Why Not Choose Just One Investment?
Warren Buffett is an investor who would probably be the wealthiest person in the world it he had not been giving away about $10 billion a year with the goal of giving it all away before he dies. Buffett says that people hedge their bets by diversifying because they do not know how to identify good investments. Alternatively, they do not have the time, patience, or expertise to make good investment decisions. Buffett says that these folks should invest in an exchange traded fund that tracks the S&P 500. Using this approach they are essentially investing in the whole stock market as a proxy for the US economy. Unfortunately, this approach is not available for crypto. You need to pick individual cryptocurrencies one at a time. That being the case, a viable approach might be to invest in equal amounts of Bitcoin, Ethereum, and Cardano for one part of the portfolio. Then invest in Tether, the cash equivalent, as another part. And last, invest in a mix of startup tokens as the third and smallest portion.
When To Buy and When To Sell In a Portfolio
Folks in the stock market who hold stocks like Microsoft, Apple, or Coca Cola usually buy and hold these investments for years or decades. Folks who buy a startup with growth potential are faced with different decisions. When the new stock fizzles they pick another new stock. When it soars and multiplies in value they commonly sell, take their profit, and look for another potential growth stock. In the crypto world the same idea applies. If you buy Bitcoin or Ether you are probably going to hold it. If you buy one of the new ones on the list we included, you will probably sell when it soars upward, before it corrects back down. This approach requires active portfolio management. A basic decision when diversifying a portfolio is whether or not you have the time, patience, and expertise to do this well. If not, stick with your Bitcoin, Ether, Cardono, and Tether, or whatever you choose and get some sleep at night without constantly worrying about the mix of your crypto portfolio.