How to Build a Crypto Portfolio
Julia Gerstein | Wed Sep 14 2022
The following is a special addition to Quantify Crypto written by Julia Gerstein, which first appeared in TradeSanta.
Let’s talk about general principles of building a portfolio, a crypto portfolio including. Also, we’ll discuss how to build a portfolio that is balanced and fits your risk profile.
Table of Contents
What is a crypto portfolio?
According to an American economist, author and professor of Management at Boston University, Zvi Bodie, an investor’s portfolio is simply his or her collection of investment assets, such as mutual funds, stocks, bonds, real estate, retirement savings accounts such as 401(k)s andIRAs. According to this logic, a crypto portfolio is a collection of your crypto assets.
You might ask, if it is that simple, what is difficult then? A really challenging question is how to design a portfolio, a crypto portfolio, or a traditional-market portfolio, in a way that will maximize your returns. There’s a separate science called Modern Portfolio Theory (MPT) dedicated to the process. It epitomizes a practical method for selecting investments for your portfolio in order to maximize overall returns within an acceptable level of risk. So if you want to go deeper, you should maybe go and check out this theory in detail.
In short, the authors of the theory, Harry Markowitz and William Sharpe, won Nobel Prizes in 1990 for the groundbreaking realization of the fact the performance of an individual asset is not as important as the performance and composition of an investor’s entire portfolio. That said, according to MPT, a key component for building a successful portfolio is diversification.
In this article, we’ll touch on the general principles of building up your portfolio from scratch, a cryptocurrency portfolio including, and, of course, diversification, too. However, you should start with asking yourself even a more general question. What do you want?
Formulate the goals for your portfolio
If you go and visit a financial advisor, they will probably tell you that, in practice, a good deal of investment management is not all theory, but the golden tree of life that springs ever green. It revolves around the individual’s aspirations. So, the advisor will probably give you a good listen first and then design an investment plan based on (1) your time horizon and (2) the importance of each goal for you.
Now that you know their train of thought, why not sketch a couple of ideas on your own? Start with sitting down and dividing your life goals into general categories:
- Lifetime savings you could use in the future for your retirement fund, college fund for your children, etc.
- Short- to mid-term savings for big life expenses such as parental support for your parents, mortgage payoff, a dream trip, a new-to-you car, new family members, a home upkeep, etc.
- Savings to grow your capital and receive dividends, such as investing in stock market and crypto market.
Remember that there is no textbook rule for how to formulate financial goals. Your goals are yours and they solely depend on what you want and over what time horizon you want to achieve them.
“Clarity is essential while setting goals,” Jason Porter, a senior investment manager at a financial consulting provider Scottish Heritage SG told TradeSanta, “for instance, instead of stating your intention to earn money, state your intention to double your investment within six months. It’s essential to set goals that you can achieve. I will recommend you to not establish unachievable goals; otherwise, you’ll simply be disappointed. It’s wise to start little when investing in cryptocurrencies if you’re a beginner and progressively raise your targets as you gain experience.”
As a way to structure your goals you can use the table below.
How much you are ready to invest
How much you want to get in the end
Example1: I want to buy a bigger house
In 1 year
I am ready to take high risk on it.
Example 2: I want to increase my current spare capital, and get 2X on it
In 5 years
I am ready to risk it for high return potential. But I am not willing to loose more then 30%.
The structure of the goals given above is a pure illustration. Also you can have a separate portfolio for each individual goal, or you can have simply one goal and one portfolio for this goal. So now that you know how to approach the process of building up your portfolio, maybe it’s time to do so. The goals are then matched with reality and are there for you to not only decide what asset mix you will have in your portfolio, but also how you are going to manage it.
A couple of principles that you should follow while building your portfolio is building it in accordance with your risk-return trade-off and a certain level of diversification. In the next paragraphs, we’ll talk about these principles in detail.
Determine your risk-return profile
That said, you’ve defined your financial goals in terms of the importance of each of them, in terms of time horizon, and now you’re building up your portfolio based on that. One more thing to consider here is the risk you’re ready to take. But what is a portfolio risk?
As the economist Zvi Bodie puts it, in practice, actual or realized returns will almost always deviate from the expected return anticipated at the start of the investment period. There will almost always be risk associated with investments, either it is crypto or traditional markets. If you want higher expected returns, you will have to pay a price in terms of accepting higher investment risk, and vice versa.
“Keep an expectation of anything around 25% based on the real value of the altcoin [in your portfolio],” says Chaz Nahas, crypto trader by day and a director at a marketing agency BuzzLogic by night, meaning that you might either gain or lose this amount of money on crypto market fluctuations.
Risk-return trade-off is an important term for you as an investor because your potential return rises with an increase in risk, and you should know your ability to take risks better than anyone else. Your risk profile is not defined by your gut, by the way, but by the number of your assets and liabilities. An individual with many assets and few liabilities has a high ability to take on risk. Conversely, an individual with few assets and high liabilities has a low ability to take on risk.
“Age is another important factor in determining your risk/reward profile, ” says Harry Turner, founder of The Sovereign Investor, an educational website about investments, “if you’re young and just starting out in your career, you may want to focus on high-risk, high-reward investments. That way, you can potentially reap big rewards if your investments succeed, and have some time to recover from any losses.”
So, start thinking about the risk-return trade-off available to you by examining the most basic asset allocation choice: the choice of how much of the portfolio to place in risky assets versus how much of the portfolio to place in less risky asset classes.
In general, when it comes down to crypto, you should always remember that, with regard to the variety of possible assets to invest in, this asset is probably the most volatile of them all. It might be a great fit, though, for your goals if it falls under your time horizon and your needs.
An American multinational financial services corporation Fidelity generally offers a few portfolio types you don’t need to be married to but have probably heard of: conservative, moderate, balanced, growth and aggressive portfolio. Go analyze these portfolio types and think which one of them suits you better in terms of perspectives suggested above.
The conservative portfolio might be good for investors who want to minimize the effect of market fluctuations by taking an income-oriented approach with some potential for capital appreciation.
The moderate portfolio offers a mix of assets that may be appropriate for investors who want to seek income and the potential for capital appreciation (with a slight priority on capital appreciation).
The balanced portfolio may be appropriate for investors who want the potential for capital appreciation and some growth and who can withstand moderate fluctuations in market value.
The growth portfolio may be appropriate for investors who have a preference for growth and who can withstand significant fluctuations in market value.
The aggressive portfolio may be appropriate for investors who seek very aggressive growth and who can tolerate very wide fluctuations in market values, especially over the short term.
Diversify your portfolio
This is the statement by John Bogle, made when he was the chairman of the Vanguard Group of Investment Companies:
“The most fundamental decision of investing is the allocation of your assets: How much should you own in stock? How much should you own in bonds? How much should you own in cash reserves? . . . That decision [has been shown to account] for an astonishing 94% of the differences in total returns achieved by institutionally managed pension funds. . . . There is no reason to believe that the same relationship does not also hold true for individual investors.“
This statement can be applied not only to traditional markets, but also to such asset class as crypto. The point is: try to diversify your crypto portfolio when possible. And try to do so in accordance with your risk profile.
In general, investors make two types of decisions in constructing their portfolios. The asset allocation decision is the choice among broad asset classes, in our case, different types of cryptocurrencies, such as altcoins, DeFi coins etc, while the asset selection decision is the choice of which particular assets to hold within each asset class.
Say, you’ve ultimately decided to add crypto to your portfolio. Now, what? In the crypto niche, there are different types of crypto assets: more established coins, such as BTC, Ether, Litecoin, BNB, and less established coins, such as DeFi tokens, such as REN, EPS, TRIBE and more. “You may monitor altcoins by watching their trading volumes, market capitalization, and network enhancements,” suggested to us Johnathan Merry, Founder of MoneyTransfers.com, a service comparing money transfer providers. The asset you might want to choose depends on your time horizon. The more established ones are good to go for longer-term investment horizons and the hyped ones might be a good short-term investment.
But even if you’ve entered into a more obscure market on its long trend, it might very well be another reason to be more cautious about the future of this token. These gems potentially give you a chance to gain more over a short-term horizon, however, the risk with them is also more significant.
Just like with the traditional markets, the process of choosing each coin for your crypto portfolio might take some time, because for every coin, you will have to conduct a technical and fundamental analysis by yourself. And when the portfolio is built up, you will have to go back to it and rebalance it every 3-6–9-12 months. As Coldplay nicely put it in their song “The Scientist”, nobody said it was easy.
“As you look to diversify your portfolio with crypto, the absence of a white paper is a sign to steer clear, “said Andrew Gonzales, a founder of BusinessLoans.com, a platform delivering access to the network of online lenders, “instead, only diversify into projects with active communities, high quality websites, and white papers which clearly define the project’s goals and strategies. In doing so, you’re far more likely to catch crypto projects with massive upside potential, rather than rug pulls and ‘pump and dump’ schemes.”
Here’s some good news, though. According to Zvi Bodie, in most cases, the asset allocation choice is far more important than specific coin-selection decisions in determining overall investment performance, so investing in crypto might get easier when you’re familiar with the overall principle.
Portfolio, a crypto portfolio or a traditional-market portfolio, is simply a collection of your investment assets, where the performance of one asset is not as important as the performance and composition of your entire portfolio.
You can start building up your portfolio with one urgent goal or dance around the life-time-horizon goals, it’s up to you. You can have one portfolio for one goal or a few portfolios for a few goals, you can have a separate crypto portfolio or a portfolio mixed out of crypto and traditional asset classes – decide what works for you best for yourself.
When the financial goals are set, either long-term, mid-term or short-term, and the investment horizon is defined, determine your risk-return trade-off by the number of your assets and liabilities and consider different portfolio types. Three most common portfolio types are conservative portfolio, moderate portfolio, balanced portfolio, growth portfolio and aggressive portfolio.
That said, in general, investors make two types of decisions in constructing their portfolios, either traditional ones or crypto portfolios. Here’s how to build a diversified crypto portfolio. You need to make two decisions: the asset allocation decision and the asset selection decision. The asset allocation choice is considered far more important than specific coin-selection decisions in determining overall investment performance.
How to make those two decisions right, though? In conclusion, here’s a couple of tips from Andrew Lokenauth, a former Goldman Sachs analyst and a founder of Fluent in Finance, an educational community for those who are interested in investments:
- When investing in crypto, understand that crypto can be very volatile, so you should only invest what you can afford to lose. Do not go all in on one coin.
- At least 60% of your crypto portfolio should be blue-chip cryptocurrencies like Bitcoin and Ethereum, which are among the most stable cryptos.
- I personally invest 10 to 20% of my crypto portfolio in small-cap altcoins. I love asymmetric risks. When you are investing in a few altcoins, you do not need all to do well, just 1 or 2 to 10x!
- Many investment advisors now recommend investing 1% to 5% of your portfolio in Bitcoin, depending on your investment horizon. Bitcoin may still be “controversial” to many but every month, we have more and more billionaires, banks and institutional investors endorsing Bitcoin. This demand will continue to push prices upward
- When investing in any crypto, understand the use cases/utility for the digital currency. Understand the problem that the digital currency aims to solve.
The views of the experts do not necessarily reflect those of the Editorial Board.
What is a crypto portfolio?
A crypto portfolio is a collection of your crypto assets across different wallets and trading platforms.
How to create a crypto portfolio?
- Formulate your financial goals and an investment horizon.
- Determine your risk-return profile.
- Make two decisions about asset allocation and asset selection.
How much of your portfolio should be crypto?
There’s no right answer for everyone. If your portfolio is conservative, you want to minimize the amount of crypto assets. If your portfolio is balanced, add a moderate amount of crypto. If you can withstand significant fluctuations in market value, increase the amount of crypto to the maximum.
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