If you’re looking to mix things up with your traditional investment portfolio and want to bring a more feisty risk tolerance to your strategies, cryptocurrency may serve to fill that role. The wildly volatile, speculative asset class has provided investors with both astounding returns and devastating losses.
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Many cryptocurrencies regularly post losses of 50% or more within months, weeks or even days, making millionaires out of some and destroying the savings of others. So, whether you are looking to build a diversified portfolio to help you achieve your short-term financial goals or long-term retirement plans, it’s typically never a good idea to put all your nest eggs in one basket.
While even the most speculative investors likely would not recommend you put all of your money into crypto, there may be a use for it as a diversification tool for your overall portfolio. As far as investment advice goes, when it comes to the market volatility of crypto, it’s always a good idea to take it slowly and follow these strategies.
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Manage Risk by Allocating a Small Portion to Crypto
If you’ve been wondering how much is too much when it comes to investing in crypto, most financial advisors and experts in the field recommend a crypto correlation of somewhere between 1% and 5%, with very few recommending more than 10%. Simply put, don’t invest more than 10% of your “risky” assets in cryptocurrencies, but finding the sweet spot may mean not investing more than 3%.
You want to limit your cryptocurrency exposure to a small percentage of your overall portfolio, which is why crypto works to diversify your overall portfolio, but shouldn’t be your entire investment strategy. This can help limit potential losses while still allowing for upside potential.
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Diversify Across Cryptocurrencies and Different Crypto Sectors
The old saying don’t put all your eggs in one basket truly applies to investing in a mix of cryptocurrencies with different market capitalizations, use cases and blockchain technologies to make sure your financial bases are covered. In general, diversification is a way to reduce the risk in your portfolio by allocating your assets to a variety of investments. To achieve optimal diversification, these investments will have low correlation with one another.
The idea is that if you have two different investments that show a positive rate of return but do not always trade in lockstep, you’ll still achieve the same long-term return but with lower volatility. For example, with crypto, consider large-cap cryptocurrencies like Bitcoin and Ethereum for stability, and explore promising altcoins for growth potential.
You can also invest in cryptocurrencies representing different sectors within the crypto space, such as Decentralized Finance (DeFi), Non-Fungible Tokens (NFTs) or Metaverse platforms. This can further reduce risk by diversifying across different areas of the crypto market. However, the only problem with using crypto as a diversification tool is that it is increasingly becoming correlated with the movements of the stock market, which is also currently a bit volatile.
Consider Stablecoins
Stablecoins are cryptocurrencies pegged to a stable asset, like the US dollar, which can make diversification a bit more, well, stable, with this strategy. When it comes to using crypto as a diversification tool, experts generally suggest sticking with something like this.
There are literally thousands of cryptos you can choose from, but generally speaking, the smaller they are, the more speculative they become. However, if you’re simply looking for diversification exposure to crypto rather than trying to speculate on a big winner, sticking with the industry leaders is generally your best bet. This can provide a safe haven during market downturns and offer a way to preserve capital while staying within the crypto ecosystem.
Rebalance Your Portfolio Regularly
As the market changes, your portfolio allocation will likely shift, so staying financially vigilant and regularly reviewing and rebalancing your portfolio to maintain your desired diversification levels is recommended. This could involve selling overperforming assets and reinvesting in underperforming ones to restore balance.
Increasing numbers of investors are using cryptocurrency as a diversification tool, and there may be some merit to the strategy. Although correlations are rising, crypto remains a speculative asset class that is fundamentally different from the stock market.
The speculative nature of crypto remains a double-edged sword, as it offers both the potential for explosive gains and the risk of enormous losses. As such, experts agree that particularly when being used as a diversification tool, allocations generally should be limited to the single digits.
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This article originally appeared on GOBankingRates.com: 4 Best Strategies for Using Crypto To Diversify Your Portfolio
