If you’re serious about building an investment portfolio, there are some basic rules for weighing your risk. While cryptocurrencies are a brave new world, these rules still apply, so if you haven’t thought about what a balanced crypto wallet entails, now is a good time to start.
Investing and trading are overlapping ideas with one fundamental thing: risk. You risk your money against an uncertain outcome. The movement (short or long term) of a stock price, a physical asset (like a house), the success of a business or a cryptocurrency exchange.
Risk means that you could lose the money you invest. Therefore, you should always only invest money that you can afford to lose, i.e. disposable income.
What does a balanced investment portfolio mean?
If you’re willing to risk your money, you should at least have some way to measure how big that risk is. Volatility is an obvious measure of how much a value fluctuates.
Maintaining a “balanced investment portfolio” means managing your investment exposure to an acceptable level of risk. This is usually achieved by dividing the portfolio into two classes with very different risk profiles: capital preservation (low risk/reward) and growth (medium to high risk/reward).
Capital preservation versus growth
Capital preservation must be evident. The goal is to preserve equity (money) and invest in low risk/low return assets. With traditional financing, these are interest-based products, such as bonds, high-yield savings accounts, or annuities.
Conversely, if your goal is growth, you need riskier assets that can significantly increase and grow your capital faster, which can range from buying shares in companies (both public and private), the purchase of real estate, commodities and cryptocurrencies.
So a traditional balanced portfolio can have a mix of bonds and savings products (capital preservation) and growth products (stocks, funds, cryptocurrencies, etc.).
The balance of these two factors depends on your circumstances, with your age and discretionary income being major contributors, but a 60/40 (maintenance/equity) split is common.
The importance of diversity
In addition to the balance between capital preservation and growth, diversification must be taken into account. Simply put, this means don’t put all your eggs in one basket.
If the growth portion of your portfolio consists only of stocks of companies based in the oil industry and crude oil crashes, you are 100% exposed to this risk.
Diversification is a way to water down the growth goal altogether and requires careful consideration because there is no easy way to tell whether two investments are related.
This is especially pertinent as we move on to discussing how cryptocurrencies fit into a balanced portfolio, as you’ll find differing views on the extent to which cryptocurrency performance as an industry corelates to traditional financial indicators such as major stock markets and currencies.
From trading to crypto
When moving from traditional finance to crypto surveillance, you should feel that it is placed squarely in the “growth” zone of any portfolio due to its volatility. As mentioned above, your situation and risk tolerance will determine which part of your portfolio is in the growth segment of crypto.
But the discussion doesn’t stop there, because a balanced portfolio can be a fractal. This means you can divide your crypto growth portfolio across assets that fall in the risk spectrum.
So crypto is on the growth side of your overall portfolio, and within that you invest proportionally to preserve capital and increase your allocation.
Capital preservation can mean investing part of your capital in Stablecoins and choosing established Cefi or Defi providers for a fixed return. There would still be counterparty risk from the Stablecoin itself and the chosen yield platform – which is why it is factored into the overall growth of your portfolio – but the volatility is low.
Your sub-allocation to cryptocurrency growth may include variable risk coins. This spectrum can stretch from Bitcoin and Ethereum through established challengers to both to the latest speculative Defi project on the Binance Smart Chain where allocation is relative to risk.
You would still apply the logic of decentralization just as you understand how the crypto ecosystem consists of different sectors with independent growth prospects.
This is harder than it sounds because you can’t always know what a project is going to do and because prices largely follow what happens to Bitcoin (known as Bitcoin Dominance). Often, crypto – as a whole – can respond to major macroeconomic shocks, as seen with the onset of the Covid19 pandemic.
That said, these filters/categories would be essential for hashing, although there are many other ways to classify crypto categories from a hashing perspective.
- POW Blockchains
- POS blockchains
- On NFT platforms or applications
- On DEFI platforms or applications
- Oracle/Data Services
- Meme Coins
- Data warehouse
I just want to yell
The problem with the idea of a balanced portfolio is that it sounds way too reasonable. You don’t have to look far from Twitter, Tik Tok, or Reddit to see that there’s a huge desire to do the exact opposite of investment portfolio rebalancing, like the idea of YOLO investing.
Yolo means you only live once and basically means going all in on risky investments. The roots of that movement are complex and probably have a lot to do with a sense of hopelessness caused by economic opportunity and a mistrust of mainstream thinking.
By introducing the idea of a balanced portfolio, we are not saying that Wallstreetbets is wrong – although it is very high risk – we are just pointing out different ways of investing. YOLO is on the other end of the spectrum and a balanced portfolio is a much more conservative approach.
Cryptocurrency or nothing?
The idea of a balanced portfolio is not rocket science. Most people who have real estate investments are probably already doing so without consciously mapping. The difficulty with the idea of crypto explaining the growth of a broader, balanced portfolio is that it comes with some difficult contradictions.
Many people invest in crypto as a replacement for traditional finance, not as a supplement. Depending on who you follow on social media, you may get the sense that the approach of many in the crypto community to investing goes beyond financial obligations and is in many ways ideological.
Seeing crypto in these terms might make you feel that a balanced portfolio approach might not be for you, but it doesn’t have to be a binary decision. You can take the logic of capital preservation, growth and diversification and apply it however you see fit.
For example, if you fundamentally believe that Defi is going to disrupt traditional financial services, consider investing in a few Defi platforms and apps that take different approaches to scaling and, where possible, diversify the perceived risks. In other words, hedge your bet.
You can save capital and gain exposure to growth by cultivating stablecoins, where APYs are much higher than fixed income products in traditional finance.
Whatever decisions you make about building a balanced crypto portfolio, make sure it is based on your own research, rather than vague data found online, gut feelings, or an irrational desire to make a profit.