At its core, trading may be just a chance game in pittings one’s informed wits against the market. But why and how to diversify to ensure a healthy portfolio? Let’s count the ways.
Trading and investing are complex aspects of finance that incorporate many elements depending on the asset class — when you are able to trade such an asset, and when you want to add it to your personal trading environment. The convenience of crypto trading, available 24/7 from virtually anywhere in the world, also doesn’t make it any easier. This means the asset is always being traded, non-stop — even when you’re sleeping. It doesn’t help that although crypto has been one of the best investments in the last decade, it remains arguably the most volatile.
With these factors in mind, it’s important to have a good, diversified portfolio to help you on your trading journey. An investment portfolio is a group of assets that you have decided to round up and make part of your personal assets of interest. It can be exclusively cryptocurrencies but doesn’t have to be; it can include other assets like equities, securities, commodities, and more. What’s more, you can have more than one portfolio — for example, one for cryptocurrencies, and another for stocks — within your investment portfolio as a whole.
One essential aspect of a sound portfolio is to have diversity in your trading and investments, in other words, have a diversified portfolio.
Portfolio diversification is the process of analyzing the group of assets that you plan to trade or invest in and separating them based on their asset class or by their behavior in the market. This enables a trader or investor to have a financial interest in multiple areas of a market or different assets instead of just one. There are various different ways to build portfolio diversification, for example:
- Global Portfolio Diversification: This type of diversification is created by investing in different assets based on their globally defined grouping. For example, having a portfolio that consists of crypto, stocks, forex, bonds, and real estate is globally diverse because those are all sorted by category type.
- Compositional Portfolio Diversification: This type of portfolio is divided by the composition of the type of asset you wish to have. For example, a portfolio with stocks and crypto is diversified but having a portfolio with stocks from two different counties may not be. In some cases, some people would consider crypto strongly defined as a currency and therefore not diversified from other currencies like Forex.
- Asset Type Portfolio Diversification: This diversification looks at the type of asset you want to trade or invest in and the diversity within that asset class. For example, tech stocks and healthcare stocks are diversified within a stock portfolio. Within crypto, a diversified portfolio may be one that has Bitcoin, Ethereum, and a few altcoins that seem promising to the owner of the portfolio.
It’s completely feasible to mix and match the examples above to make things even more diversified.
Why a diversified portfolio makes sense
What are some reasons to want a diversified portfolio? Wouldn’t it make more sense to find an asset you really like or one that is performing very well and go “all in”? This is always a topic that’s up for debate but there are five reasons why a diversified portfolio usually makes more sense.
- Statistical Advantage: One reason why a diversified portfolio makes sense is that statistics have shown that a portfolio with different types of assets performs better than one that is all or nothing into one particular asset. It’s one method that allows you to gain an advantage by gaining something instead of gaining a lot. Traders and investors that focus on “shooting for the moon” often miss completely and miss out on what they could have gained simply by using a diversified method.
- Risk Reduction: Separation of assets into types can help reduce risks associated with portfolio loss. For example, if you had Bitcoin during early 2018 and that’s all your portfolio contained, you could have lost up to 86% depending on when you owned that Bitcoin. Owning half Bitcoin and half gold for example would have reduced the amount you lost. Diversification prevents the change that huge losses will be commonplace.
- Opportunity Benefit: If you have more asset types in your portfolio, chances are this helps you obtain an asset that’s a real winner. For example, if you had stocks in the oil sector combined with Ethereum and also real estate property, you would have been dissatisfied with your oil stocks in comparison to Ethereum, which has gone as high as 1,500% depending on when you bought. Having a diversified portfolio with 10% Ethereum at $200 would equate to 60% of your portfolio today. Diversity gives you the opportunity to capture these wins.
- Volatility Concerns: In a similar vein to risk reduction, a diversified portfolio helps prevent massive swings in price depending on the asset, which can lead to things like panic and stress. Diversifying your portfolio between volatile and nonvolatile assets can help reduce the overall swings in price and help you have more peace of mind.
- Capital Preservation: By covering yourself in reducing risk and volatility, a diversified portfolio by default would help preserve and retain the amount that you have invested. Sometimes preserving is the best way to keep gaining success in your portfolio. Besides, you can’t make money if you don’t have a portfolio at all.
Diversification is the key to success
The whole purpose of investing is to multiply your portfolio and make it grow. No one ever wants to lose money trading and investing, yet the very nature of market movements doesn’t always comply with an investor’s goals.
Diversified portfolios are critical and often a key to helping you succeed in trading and investing by reducing your risk while also giving you just as much upside potential. In addition, it helps reduce massive fluctuations in the value of your portfolio and keeps things a little more steady. As long as your portfolio remains healthy, it can help balance any potential risk while also creating more opportunities for growth.
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Note: BTSE Blog contents are intended solely to provide varying insights and perspectives. Unless otherwise noted, they do not represent the views of BTSE and should in no way be treated as investment advice. Markets are volatile, and trading brings rewards and risks. Trade with caution.