Diversification is a financial risk management strategy that involves the use of a wide range of diverse investments within the same portfolio. In fact, a combination of various types of assets, types of cryptocurrencies and investment instruments in order to reduce the impact of each individual asset or risk. In the long run, this provides more profit.
The basics
The basis of diversification is to smooth out the impact of unsystematic risk events on the overall portfolio of securities and tokens, since positive results for some assets will overlap negative ones for others. But this means that the values of different cryptocurrencies and securities should correlate as little as possible with each other. Ideally - in almost the opposite way to respond to various market influences.
Practical research and mathematical models have shown that a well-diversified portfolio of stocks and cryptocurrencies contains about 25-30 different elements. In such a situation, economic risk is minimal. A further increase in diversity brings benefits, although to a much lesser extent, since it seriously complicates the entire process of working with assets.
Classification Diversification
The easiest way is to distribute your assets into different classes in different (or equal) percentages. Classes are the following varieties:
- Stocks and bonds of public companies
- Government bonds and other fixed income debt instruments
- The property
- ETFs
- Goods and raw materials
- Cash and cash equivalents - treasury bills, certificates of deposit, etc.
- Cryptocurrency
First, a certain “total percentage” is determined for each class. Then - diversification is carried out already within its limits. Usually, they are invested in approximately the same degree in assets which value does not correlate with each other. Speaking of cryptocurrencies, you can simultaneously invest in a couple of stablecoins (high stability) tied to different real currencies or gold, in classic Bitcoin and in something based on Ethereum.
External diversification
More relevant for those investors who work with a variety of stocks, since cryptocurrencies are mainly not tied to the borders of one country.
The point is to invest part of the funds in assets that are not dependent on the economic situation in the investor’s residence country. And if something really unpleasant happens, independent assets will provide some “safety cushion”.
In the context of crypto, this is less relevant. At least for now, the “national cryptocurrencies” planned for release by the governments of different countries will not acquire real significant proportions.
Diversification and retail investment
This investment tactic involves the use of significant temporary and financial investments, which can be problematic for a novice investor. One solution to this problem is mutual investment funds. This is when many small investors pool their funds and transfer them to professional financiers, making a profit proportional to the percentage of invested assets. In the context of cryptocurrency, the situation is identical to organizing a common pool for staking or a pool for mining. Usually, such mutual funds by default support high diversification. And they allow ordinary people to have benefits from work with stocks and commodities that require a huge investment.
Disadvantages
The advantages of this investment approach are obvious - reducing risk and creating some kind of volatility buffer. But there are disadvantages to this investment strategy.
- Less risk, but less profit overall. Such an approach generally limits all possible random events, both positive and negative.
- Less short-term profit. In the long run, diversification is more profitable, but it interferes with working with short-term and rapid market fluctuations.
- Large associated costs. The more difference in assets, the greater the commission when working with them. Purely due to the number of actions.
- The complexity of the work. Keeping track on a couple of selected cryptocurrencies is not difficult. But when their number exceeds the second ten, it becomes difficult to track the dynamics of changes and predict the reactions of each.
Conclusion
In general, diversification is an extremely profitable strategy for a novice investor who is not ready to actively take risks and who is not yet able to quickly respond to world events and calculate their impact on the value of assets. And it doesn’t really matter if it is about stocks, bonds or cryptocurrency tokens.