We may live in the “modern” world, and certainly technology has advanced at an incredible pace over the last several decades, but that doesn’t mean that your grandmother didn’t give advice that is still good and applicable today.
That is at least true with this one piece of advice: Don’t put all of your eggs in one basket.
Now, you may not be a homesteader and may not have your own chickens (I’m perfectly good with getting eggs at Ralphs, thank you very much), but the point of spreading out your risk is a smart one.
Especially when it comes to investing.
You’ve heard it before
If you’ve spent any time in the investing world, you’ve heard the recommendation to diversify your investments. Diversification is the opposite of “concentration risk” – overemphasizing specific assets or sectors.
So, if we look at the world of cryptocurrencies, for many people, diversifying with crypto means buying bitcoin exclusively.
And on one level, that can seem to make sense. After all, bitcoin pricing at the time of this writing is $109,237 per coin. Anders Bylund of the Motley Fool reminds us that “a $1,000 bitcoin purchase on Aug. 20, 2020, would be worth roughly $9,784 five years later.”
That’s 878% overall growth, or 57% compound annual growth over five years. What my Grandma would’ve described as, “Not too shabby!” (She really had a gift for understatement, bless her heart.)
Of course, as with all investments, returns on investments aren’t guaranteed. It’s this very lack of guarantees and the risk of loss that gives the potential for impressive returns.
And if you’ve been with us here, reading our articles for even the last month or two, you know that…
Cryptocurrencies have gone mainstream
In this case, that means that it’s not just early adopters and venture capitalists who are investing in cryptocurrencies. Even institutional investors like banks and large corporations have made cryptocurrencies part of their investment strategies.
Those types of investors generally aren’t ones to take extreme risks in their investing. They will take risks, of course, because without any risk, there is no hope of any gain. But they aren’t taking risks that they don’t think that they can’t safely weather.
And how are they making sure that they are able to take advantage of the opportunity presented by investing into cryptocurrencies without setting themselves up for losses that they can’t handle?
Diversification.
Just like Grandma said.
Don’t put all your eggs in one basket (even if it’s a really great basket)
But even though this advice sounds simple and straightforward, how to apply it may not always seem obvious especially if your focus is primarily on cryptocurrencies for your investments.
After all, with bitcoin’s long-term ROI, who wouldn’t want to put all of their investment dollars into that one coin?
Two reasons:
One: The fact that bitcoin has been the single most popular crypto asset may very well mean it’s very late in the adoption curve, and future gains will be much lower, or much slower, than past gains. In other words, you can’t hop in a time machine, go back to August 2020 and score 57% compound annual growth! That’s off the table. (Which is why you always see the words “Past performance is not a guarantee of future results” – it’s the truth.)
Two: Risk management. Remember, there’s a reason that financial specialists recommend diversification. Proper diversification helps to manage risk.
The idea is that you want the possibility of the growth that you want while still being able to sleep at night because you have stability with a solid block of your investments. I really, really love this description from the SEC:
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.
(Yes, they really call it “magic”!)
So, you may want to spread your cryptocurrency allocation across several different coins.
Mostly, it’s because of risk. Risk is, pretty much by its definition, unpredictable.
Yes, bitcoin has impressive overall appreciation over time. But you also have to realize bitcoin has had some nasty downturns, too. The term “volatility” is the investing shorthand for this behavior – high volatility assets have eye-popping surges as well as gut-wrenching declines. That’s a feature, not a bug.
So, in the short term, you might see one cryptocurrency (yes, even bitcoin) take a sharp downturn. Maybe the entire crypto market will go through another crypto winter. But if you’ve diversified across a number of other asset classes beyond crypto, your overall savings won’t take a major hit.
And you’ll still benefit overall when one or more of the cryptocurrencies in your portfolio gain (and sometimes cryptocurrencies gain big – bigger than anything else).
The opposite side of “risk” is “reward.” Asset allocation, where and how much you diversify your savings, is a critical factor in your ultimate success. Again from the SEC:
In addition, asset allocation is important because it has major impact on whether you will meet your financial goal. If you don’t include enough risk in your portfolio, your investments may not earn a large enough return to meet your goal.
The important thing here is to be a mindful and responsible investor. That means knowing how much risk you can tolerate without your stress levels going through the roof. And as long as you’re within your own personal risk tolerance, that means that you can diversify your savings with cryptocurrencies that show the best growth potential.
It’s the best of both worlds when you take responsibility for your investment choices, retain control of them – and invest in a mix of cryptocurrencies that you choose.
Investing control and tax advantages, too?
Another of the good things about the time that we’re living in is that you can make your own investment choices, you can maintain control of your portfolio to reach your investing goals (not someone else’s) and do so in a tax-advantaged way.
How? By managing your cryptocurrency portfolio through a tax-advantaged Digital IRA. Find out more about how a Digital IRA can help you reach your investing goals by getting our free Insider’s Guide to Crypto IRAs. Or, if you’re already convinced crypto is right for you, you can open your Digital IRA right now (anytime, day or night) in less than 10 minutes.
