A smoother ride limiting portfolio overconcentration – bitcoinadstrain

It’s simple to be an armchair investor. Just pull up a chart of the latest hot crypto, stock, or ETF and bewail the fact that you didn’t have all of your life savings riding it to insane new highs. Most, if not all, crypto traders have experienced similar remorse at one time or another. Looking closer, however, there are many sound reasons to never plow the majority of your risk capital into any single crypto. Some of the rationales are obvious, but others will require you to think outside of the box. Limiting portfolio overconcentration is easy enough, as long as you keep your emotions, fear of missing out (FOMO), and greed in check.

Here’s a closer look now. A Fraction of Your Net Worth

In this article, we’re looking at how to avoid investing too much of your risk capital into any given trade. We won’t be discussing the equally important issue of how much of your net worth should be allocated for crypto investing and speculation. However, let’s just say that you should strive to allocate only a fraction of your total net worth (house, personal property, savings, retirement accounts, etc.) into the crypto markets. Only you can determine the appropriate amount to invest in cryptos. However, it should be modest enough so that if you were unfortunate enough to lose it all, your lifestyle would not be affected. Divide Your Portion Unto Seven or Eight

Solomon was referring to allocating your risk capital across significantly different kinds of investments. In previous articles, you’ve seen the relative strength performances of Bitcoin vs. tech stocks, gold, real estate, and emerging markets stocks. Bitcoin was the unchallenged winner over the past two-, three- and five-year periods. However, Bitcoin has severely underperformed all four of those financial asset classes since December 2017. King Solomon might have suggested that you allocate an equal dollar amount of your risk capital across all five of those key markets. You would have enjoyed a smoother portfolio equity curve, simply by limiting portfolio overconcentration.

Bitcoin declined by nearly 85 percent between December 2017 and December 2018, making a powerful case for conservative asset allocations. Such a decline would have been dismissed as unlikely (if not impossible) by many late-stage (Q4 2017) Bitcoin investors. Consequently, they may have plowed far too much cash into the coin as it soared ever higher. Then when Bitcoin reversed hard to the downside, they might’ve experienced extreme stress, if not outright panic.

Traders and investors often forget that the outcome of any given trade is almost 100 percent random. The outcome is independent of all the series of winners (losers) that preceded it. And yet, crypto enthusiasts can still be tempted to bet the ranch based on favorable news, chart patterns, or extremes in investor sentiment. Should any rational investor deploy two-, five- or even 10 times their normal cash allocation on a trade that’s really just a 50-50 tossup? Of course not. Yet, traders and investors continue to make this critical mistake every single day.

The Bitcoin-only portfolio offered the most profit potential. By far, no debate at all. However, it also would have been the most difficult for investors to stay with for the long haul. Very few investors (crypto or otherwise) can handle 70-percent open-gain drawdowns. Nor can many deal with the stress of a nearly 65-percent underwater equity drawdown (when your portfolio drops beneath its original value), and that’s right out of the gate! Neither portfolio one or two had drawdowns even remotely as severe as did the Bitcoin-only portfolio. All told, portfolio two looks to be the hands-down winner in this three-way shootout. Limiting Portfolio Overconcentration

However, the big idea is that you understand the importance of diversifying across fundamentally different asset classes (at least five and perhaps as many as ten) in equal dollar amounts. As you become skilled in doing so, your portfolio equity curve will become straighter. Your drawdowns will be smaller and your stress level will also diminish.