Reposted from our blog here.
From J.P Morgan’s announcement of opening crypto trading to Mastercard’s partnership to aid banks in distributing crypto cards, it is evident that crypto activity is on the rise. As such, many investors have started parking their funds into cryptocurrency. A report by Business Insider also shows that 106 million users have invested in crypto globally, following a 16% jump from December 2020.
However, investing in the crypto market may be intimidating and overwhelming for beginners and young investors. There are a ton of currencies available, and it may be tricky to know which to invest in. Instead of putting your eggs in one basket and only investing in one type of currency, a better option is to diversify your portfolio.
What is Portfolio Diversification?
Ever heard of the term “don’t gamble by going all in”? Portfolio diversification is precisely that.
It refers to the act of buying into a range of different investment products to limit and reduce your overall risk to one type of asset. For example, if the price of Bitcoin dips, you can rely on other currencies such as Ethereum that may do better in certain periods.
More importantly, portfolio diversification helps to minimize unsystematic risk. Unsystematic risk refers to the risk that is related and unique to a specific industry, market, or company. Unlike systematic risk, which any individual cannot control, unsystematic risk can be managed to a certain extent by diversifying your portfolio.
However, before knowing what to buy and how to diversify, you must consider two key things: understanding your risk profile and the timeframe you wish to invest.
Understanding Your Risk Profile
Investing in cryptocurrency has its risks, and it is crucial to know how much risk you are willing to take. If you are risk-averse, you would likely choose to diversify your portfolio with a range of different crypto options that come with varying levels of risk. This would include Bitcoin and Ethereum, which are known to be rather volatile, as well as stablecoins like USDC and USDT that are said to be less risky.
This would mean that even if Bitcoin or Ethereum happens to do poorly, you can rely on stablecoins to help cushion the impacts.
If you are risk-neutral or enjoy taking risks, you would likely diversify your portfolio with options like Bitcoin without including safer currencies such as stablecoins. While these are indeed riskier, they may give you higher returns - and more significant losses too.
Once you are able to identify your risk profile, you can then begin to pick and choose the type of currencies to invest in. This will enable you to diversify your portfolio based on the amount of risk you are willing to take.
Timeframe of the Investment
Many of us invest in cryptocurrencies for a variety of reasons - whether it is to save up for a car or for retirement purposes. These reasons come with different timeframes that we need to consider when diversifying our portfolio.
If you have a short-term goal, such as saving up for a car, it would be better to invest in 'safer' options such as stablecoins. This is because short-term goals have a shorter time horizon, which means that buying into products with more reliable returns can help you achieve your investment goals.
However, if you are investing to save up for retirement, you may want to consider including riskier options when diversifying your portfolio. These may provide you with greater returns over a long period.
Portfolio Diversification Examples
Now that you have the basics sorted, here’s how you can diversify your portfolio, taking into account the factors we have mentioned.
Portfolio A: BTC and ETH only
Say Sally invests in both BTC and ETH. If the price of Bitcoin dips by 20% overnight while Ethereum rises by 20%, Sally would be able to counter the loss from Bitcoin from her investment in Ethereum. If she were to only invest in Bitcoin, she would have had to bear the entire 20% loss. But because she diversified her portfolio by buying into both Bitcoin and Ethereum, she was able to save some of her losses from Ethereum’s bullish returns.
However, in a case where both the prices of Bitcoin and Ethereum fall, Sally would not be able to dodge the losses. If Sally is risk-neutral, this might not affect her as much. However, if she is risk-averse, Sally can opt to buy into more asset classes to further diversify her portfolio.
Portfolio B: BTC, ETH, and 2-3 Altcoins
In this scenario, Sally buys into Bitcoin, Ethereum, and two other altcoins, such as Dai (DAI) and USD Coin (USDC). Now, Sally would be able to cushion the impacts of the losses from BTC and ETH from her investments in DAI and USDC.
This exemplifies the fundamental purpose of diversifying your portfolio to mitigate any risks and negative impacts from price swings.
How to Invest $1,000 in Crypto?
With the foundation of portfolio diversification covered, we look into how you can invest $1,000 in crypto.
Say you’re someone who is risk-averse and looking to invest for a long period of time. As such, you can choose to put $300 into BTC and ETH each. This would give you a remainder of $400, which you can split evenly between stablecoins like USDC and DAI.
Buying into four different currencies with varying risk levels would ultimately help you reduce the risk of losses. You can also buy into more asset classes once you have more capital to invest in. This would allow you to further diversify your portfolio to spread out your risk amongst different currencies.
Hodl Your Crypto in an Interest Account
Besides diversifying your portfolio to alleviate the impacts of unsystematic risk, you can also choose to store your crypto assets in interest accounts such as Hodlnaut. Depositing your cryptocurrencies in interest accounts would allow you to generate greater yield on your initial investment.
With Hodlnaut, you can earn up to 12.73% APY on six supported cryptocurrencies, namely, Bitcoin (BTC), Ethereum (ETH), Wrapped Bitcoin (WBTC), USD Coin (USDC), Tether (USDT), and Dai (DAI). Once you have deposited your crypto assets into Hodlnaut’s Interest Account, you will start earning interest at a compounded rate paid out weekly.
In addition, Hodlnaut recently launched its Preferred Interest Payout feature, which allows you to pick the currency on which you prefer earning interest. There are also no minimum deposits and lock-in periods.
Portfolio diversification is an integral part of investing, whether in cryptocurrency, stocks, or even real estate. Its main aim is to help manage unsystematic risks to allow you to attain your financial goals. But before jumping into diversifying your portfolio, it is important to understand your risk profile and your investment timeframe. This is critical so that you can decide properly on what to buy into.
Another way to minimize risk is to deposit your crypto into interest accounts such as Hodlnaut. You can earn up to 12.73% APY on your crypto assets, on top of what you can possibly earn when the prices of crypto appreciate.