Cryptocurrencies, while gaining much wider acceptance, are still not really understood well by the majority of people, at least in terms of wise investment principles to work from, even by people who are already investing into crypto.
Too many people haven’t studied crypto and are still under the illusion that cryptocurrencies, as a general investment category, are very risky, and, therefore, they stay away from crypto.
Still others have that perception of risk and treat investing in cryptocurrencies as a lottery or a con to get in on. They think that if they can just put their money on that one right coin before the market jumps on it, they can cash in before everyone else loses their money.
The thing is, both of those groups of people are wrong when it comes to applying those ideas to cryptocurrencies in general. Crypto has gained respectability and interest from institutional investors for a reason, after all, and that reason has nothing to do with insane amounts of risk or with conning people out of money.
Far from it.
Having said that, cryptocurrencies are an investment category, and like any investment category, there are principles to work from to make that investment work for you in the best possible way.
With that in mind, we’re going to talk about five principles of wise cryptocurrency investing.
#1: Understand both the risk and the reward
The first principle is understanding that cryptocurrency is an investment, and all investments have risk.
The thing is that it is this risk that gives the potential for reward!
No risk means no reward from the asset. Thus, the highest growth potential also comes with the greatest risk.
Now, that doesn’t mean that every high-risk asset also comes with high reward potential. Some types of assets (like memecoins) offer nothing but what I call “reward-free risk.”
So what’s the right amount of risk for you? Read on…
#2: Know thyself
As Polonius told his son Laertes in Shakespeare’s Hamlet:
“This above all: To thine own self be true.”
Good advice! But how does it apply to cryptocurrencies? Know your risk tolerance.
Ryan Ermey with CNBC writes,
Generally, the better you can handle an investment going down, the higher your risk tolerance.
In other words, if you’re extremely risk averse, then you’ll choose a mix of investments that offers both lower return and lower potential loss. And the reverse is true, too.
(If you need help evaluating your risk tolerance, the University of Missouri has a free online Investment Risk Tolerance Assessment you can take in about 10 minutes. There are lots of other free risk tolerance assessments available online, but most of them are produced by investment companies – I selected the U of M test because at least they aren’t trying to sell you anything.
So, if you know your risk tolerance, you can make investment decisions that satisfy your desire for growth potential without giving yourself an ulcer or stress-induced insomnia.
Now that we know ourselves, what else must we know?
#3: Do your due diligence
Which brings us to our third principle: Do your due diligence. Erney quotes CFP Joshua Brooks to help set the stage:
“Just like any investment, you need conviction based on research,” [Brooks] says. Maybe you want to hold bitcoin because you like its potential as an alternative currency. Maybe you like ether for its role in smart contracts.
Whatever your reason for holding crypto in a retirement account, it’s essential that you have a long-term thesis that you can periodically reassess. Otherwise, you’re just hoping things will continue to go up, says Brooks.
“It’s essential that you have a long-term thesis” because, if you don’t, you run the risk of simply chasing performance. You really do want to have a reason for buying and owning any asset.
“Just hoping things will continue to go up,” well, to some degree that’s what every investor does. But wise investors know why prices rise. Like scientists, wise investors have a hypothesis, something like: “Bitcoin is an undilutable store of value asset – so money-printing should drive up bitcoin prices.” Then they can test their theory in reality, see whether it holds up and (when necessary) change their minds.
Without that? Well, let me remind you that hope is not a strategy.
After you know yourself, and you’ve done your due diligence, what’s next?
#4: Don’t overextend
Understand, this is a smart principle to use for everything in your life. For example, I absolutely love pumpkin pie. One slice of pumpkin pie is divine. Two slices is a bit much – and that one time I at a whole pie by myself? Nothing but regret…
In investment terms, read this as follows: Even if your due diligence pays off, it’s better to make lots of small moves than one big one. In terms of high-risk assets, it means be cautious about doubling down on success. Instead, consider rebalancing to redistribute your gains out of an overperforming asset, into an underperforming asset. Rebalancing like this is challenging – it’s hard to sell a winner! – but it also helps you keep your savings properly diversified.
And diversification is the most powerful idea. You never want to have all your savings in one single asset class, let alone one single investment. There are over 10,000 financial assets available to buy today – and another 10,000+ cryptocurrencies! What are the odds that you’d pick the best one out of over 20,000 choices? Worse still, what do you risk losing if you guess wrong?
That’s why the principle of diversification is one of the cornerstones of modern investing. As the Securities and Exchange Commission (SEC) tells us:
The Magic of Diversification. The practice of spreading money among different investments to reduce risk is known as diversification. By picking the right group of investments, you may be able to limit your losses and reduce the fluctuations of investment returns without sacrificing too much potential gain.
Learn more at the Investor.gov website.
Proper diversification offers the best of both worlds: Growth potential with lower volatility – and ideally without extreme stress. Diversification helps you keep more of your savings.
And that leads us to our final principle…
#5: Use retirement accounts to keep more of what you make
Short-term capital gains taxes can reduce your profits by 20-37% (or more, depending on your tax bracket and state of residence). That’s quite a haircut!
That’s why it’s very smart to make use of tax advantaged accounts as much as possible when investing for retirement. This is especially important with high growth potential assets like cryptocurrencies – where big gains can lead to big, surprising and unpleasant tax bills…
Retirement accounts help you minimize your tax liability as much as legally possible. That’s one of the major reasons we started BitIRA. If you’re savvy enough to diversify with cryptocurrencies at all, I’m confident you understand the additional benefits of tax-deferred or tax-free investing with a Digital IRA.
If you’re ready to put these five principles to work for your retirement savings, you can open your Digital IRA right now (anytime, day or night) in less than 10 minutes.
Or, you can begin your due diligence with a free copy of the Essential Guide to Digital IRAs.
Whether or not you choose to open a Digital IRA with us, please make use of these 5 principles to guide your decisions.
