According to a recent survey by GOBankingRates, about a quarter of people invest in digital currencies. This alone makes cryptocurrencies worth investigating as it represents a large amount of money flowing into the asset class.
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Of course, it’s hard to avoid hearing about cryptocurrencies in the financial news these days, as Bitcoin prices typically trade continuously throughout the day. Big winners, like the amazing return of the Shiba Inu in 2021, also make headlines.
But should digital currencies really be part of your investment portfolio? These are the reasons why some experts believe so.
The basic purpose behind investment diversification is to limit risk. As cryptocurrencies are extremely volatile, it pays to diversify that risk with more traditional investments like stocks and bonds. But the opposite is also true.
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According to Michael Kelly, CFA of Switchback Financial, “I see (cryptocurrency) as a valid asset class in a portfolio due to its lack of correlation with traditional stock and bond investments.” Kelly sees crypto as a potential opportunity, but still limits client exposure to a 1-2% allocation.
Ark Investment Management CEO Cathie Wood goes even further when it comes to the potential diversification benefits of cryptocurrencies, telling CNBC that it is “the Holy Grail of diversification.” According to Wood, “institutional managers should look for new asset classes that are evolving and have low correlations.”
Anjali Jariwala, founder of FIT Advisors, suggests that you should diversify further, including within your crypto allotment. According to Jariwala, the real benefit of diversifying into cryptocurrencies is to limit extreme outcomes. If one cryptocurrency fails and your investment hits zero, other cryptocurrency investments can still do just fine. Ideally, Jariwala says, your entire crypto portfolio won’t disappear because of one coin.
In addition to avoiding a complete loss on your portfolio, diversifying your portfolio with crypto can help you improve overall. Although the journey has been extremely difficult, Ethereum, for example, has returned more than 30,000% since its inception in 2015. A small allocation of your portfolio to cryptocurrencies will not only smooth out the ups and downs in the volatile asset class, but which can also generate juice. their total returns.
With the price of most cryptocurrencies taking a beating starting in mid-2022, this could represent a buying opportunity for risk-averse long-term investors. If you properly diversify your portfolio by not being too overexposed to cryptocurrencies, even a significant loss won’t take more than a few percentage points off your total portfolio return.
Cryptocurrency bulls see the sky as the limit for cryptocurrencies. As Wood told CNBC, “Institutional investors moving into Bitcoin could add $500,000 to its price, if they ultimately give it a 5 percent allocation.”
There is no denying that the potential for cryptocurrencies to change the very nature of financial systems in the future is exciting. However, since this asset class was essentially created from scratch and is still a very new way of investing, it also carries immense risks. Here are just some of those risks:
Crypto is still speculation
The bottom line is that for all the excitement that cryptocurrencies bring to the investment world, it is mostly backed by the hopes and dreams of its investors. While some cryptos have real-world functionality, they are not backed by income or earnings like stocks are. Rather, investors back coins that they believe will become something bigger or will simply be pushed higher by a mob of speculators.
To help reduce this risk, stick with the big names in the space. According to Anastasiya Belyaeva, head of growth at PieDAO, a platform that offers investors a variety of cryptocurrency portfolios, “if you are a new investor, betting on coins and projects that have been around for a while and have proven that they are at least not a scam is a good idea,” Belyaeva said. “Investing in something that’s been around for a couple of weeks is probably risky for new investors.”
Crypto is highly volatile
Even if some cryptos turn out to be “the next big thing”, as a general asset class they are extremely volatile. In early May 2022, for example, the Terra stablecoin, which was supposed to hold a value equivalent to $1, fell off a cliff and dropped to just 9 cents per coin. This sent a huge ripple throughout the crypto world, wiping $200 billion worth of crypto from the world in a single day, according to CNBC.
When so-called “stable” currencies can crash by 91%, and former big winners like Shiba Inu can plummet 87% from their all-time highs, you need to be prepared to handle big swings in your portfolio. For many investors, this is simply too much to digest.
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