Investing involves risk and without risk there is no reward. However, there is a difference between taking unmanaged risk and calculated risk. Unmanaged risk is simply gambling/speculation or having a concentration in a specific sector or investment.
Managed risk is diversifying your portfolio among various types of uncorrelated investments known as asset classes. An example of an asset class is the S&P 500 which is composed of the 500 largest US companies. Another asset class is the Russell 2000 which is composed of the smallest US companies. Real estate, international developed, or emerging markets are other examples as well. Each of these asset classes have their own unique characteristics that when combined together provide a solid portfolio.
The ultimate goal is to develop and maintain a diversified portfolio because the number one way to manage risk and improve portfolio performance is through diversification.
Crypto and virtual currencies such as Bitcoin and Ethereum are examples of an asset class. How much you should allocate to each asset class is dependent on your risk tolerance. The higher your risk tolerance, the more you can allocate to more volatile asset classes. The lower your risk tolerance, the less you should allocate to volatile asset classes.
What is volatility?
There are many measures of volatility. In investment terms, volatility is measured as standard deviation which is how much an investment deviates, either up or down, from its mean (or average).The higher the standard deviation of an asset, the greater the risk and return. Conversely, the lower the standard deviation, the lower the risk and return.
According to a study by professors from Indiana University, the standard deviation of Bitcoin was 70% and 65% for Ethereum in an 8 year period ending in June 2018. Comparatively, the standard deviation for the S&P 500 for the same period was 3% and 4% for the tech heavy NASDAQ index.
How much should you invest in crypto and virtual currencies such as Bitcoin and Ethereum?
First off, only invest as much as you’re willing to lose. Unlike stocks, bonds, or real estate that either earn income and/or are backed by actual companies or physical assets, virtual currencies do not earn any income nor are they backed by any hard asset.
If you do decide to invest in Bitcoin, Ethereum, or any other virtual currency, plan to hold it long-term and don’t get nervous if it fluctuates significantly, because it will. Long term is defined as greater than 5 years.
Stay diversified. Allocate no more than 10% of your total portfolio all virtual currencies combined. If the value of your virtual currencies rise and now your allocation more than 10%, remember to rebalance to reduce your risk.
Looking for an independent fiduciary financial advisor who can advise you on investments, retirement, real estate, alternative assets, and taxes? Contact ACap Advisors & Accountants to schedule a free initial consultation. Our clients include individuals, small businesses, entrepreneurs, and anyone serious about saving and investing for their future.
