Crypto portfolio construction: the basics
12th September 2022 |
Firstly, apologies for the delay in your latest edition of Sam Volkering’s Crypto Network. My schedule over the last few and next few weeks has been and is nothing short of hectic.
Hence, in these times, there may occasionally be a delay in getting the publication out to you exactly on time, all the time.
This week, I’m in transit to Australia for a crypto conference. That means a day in flight time (losing a day and a half in time-zone adjustment), four days in Australia, and then back on a flight back to London, losing another day.
But I will be working the whole time, just from airport lounges, aircraft and hotels. Yay!
Anyway, I do expect I’ll have some interesting developments to bring you once I’m back, as I’ll be rubbing shoulders with the movers and shakers of the crypto world while I’m out there –and hopefully making some new contacts.
For now, though, I wanted to talk to you about something that I’m not sure is familiar to many people. Or, people perhaps don’t think about it hard enough.
Portfolio construction
Last week, I spoke with two people who know a lot about portfolio construction in traditional finance. And I myself have been a student of portfolio construction for decades.
Before I got into financial publishing, I was an independent financial adviser. I would advise retail investors on how to appropriately build a portfolio with a mix of asset classes and exposure dependent on their goals, plans, life stages and understanding of the markets.
Knowing the basics on how to build a portfolio tailored to yourself is a vital part of being a successful investor long term.
However, crypto clouds this situation quite a bit.
The speed and ferocity at which crypto can move, and the astronomical returns it can provide make people think twice about the basics and the importance of smart portfolio construction.
That’s why, today, I want to clear the haze and give you my take on how you should be looking at portfolio construction within the crypto world.
Step 1: Know your risk
One of the biggest mistakes an investor will make getting into crypto is going “all in”. If your allocation to crypto is 100% of your entire wealth, you might want to reconsider your approach.
While I fully understand the “YOLO (you only live once) trade” idea, where someone will invest everything they have (and sometimes more) into crypto, I don’t think it’s smart. The YOLO trade is a complete acceptance of all risk.
This is quite a binary outcome. It will end one of two ways: in absolute glory, or absolute fire. More often the latter.
I regularly hear stories about people who have simply invested more than they are comfortable risking because they’ve gone too deep and not properly considered the risks of the market.
It’s one thing to say that you’re comfortable risking an amount in an investment, but your comfort levels are not really tested until you actually do lose it.
While it’s not something I suggest you test out – after all, you don’t want to lose money – it’s true that suffering a loss can help you understand what your risk tolerances are. So, rather than actually losing money, I suggest that you think very carefully about just how much you’re willing to risk.
Once you know that, then you will also conclude that your entire wealth portfolio should also use this approach.
Step 2: Do you have the right mix?
If you have stocks, you need to think about how much you’re prepared to risk there, too. The same applies for any asset with an element of growth potential. As we all know, prices go up and down.
Understanding this will help you allocate your wealth to different parts of a portfolio. For instance, how much do you invest in crypto? Is the amount the same, more than, or less than the amount you invest in the stock market?
And what about property? Some people have zero property exposure. For others, property represents their primary net worth. That’s all well and good, but remember that real estate is an illiquid asset. To sell a property you live in means you need to buy somewhere else to live as well. And there are other costs involved.
These are issues people don’t consider most of the time.
And with stocks, where do you hold your investments? In an ISA? A private pension? In a regular stocks and shares account? Are they listed or unlisted? Liquid or illiquid?
Also, how old are you? Are you nearing retirement? Do you need to ensure some kind of capital preservation or income if you’re thinking about retiring?
You need the right mix of investments in a portfolio to ensure that you’ve got the potential to weather any storms, but also capitalise on any great opportunities. This is where understanding your risks will help you to apportion your mix of assets.
For example, a broad portfolio in a traditional sense might have something like cash, bonds (or bond-exposure investments), property, stocks and perhaps a handful of alternative investments.
And now, with the arrival of crypto, you should slide crypto into that mix.
Crypto investment in a smart portfolio should really only be a portion of your overall wealth. The size of that portion is your call to make, based on risk, your goals and plans, and how much sleep-at-night factor you want to play with.
But getting the right mix is crucial.
Step 3: Get the mix within your mix right
Once you know how much you want to allocate to crypto, how much you’re prepared to risk, and the outcomes you want from it, you need to determine your “crypto mix”.
This is the mix of crypto within your portfolio allocation to crypto.
Think of it as a portfolio within a portfolio.
How you construct your crypto portfolio can be a little trickier. While exposure to the big two, bitcoin and Ethereum, is a sound approach, there’s also a balance to be struck with exposure to the big exiting opportunities around interblockchain communication, DeFi (decentralised finance), Web3 and NFTs (non-fungible tokens), gaming, the metaverse, and layer-1 or layer-2 applications. It’s quite a minefield.
However, so long as you bear in mind the same principles of understanding risk, of capital allocation and your outcomes, goals and plans, there’s no reason why figuring out what to opt for shouldn’t be relatively straightforward.
Remember…
- Know your risk
- Know that crypto should be a part of – not all of – your bigger wealth portfolio
- Diversify your crypto within your crypto allocation – again, mindful of the risk, the areas of opportunity and your longer-term goals and plans.
Until next time…
Sam Volkering
Editor, Sam Volkering’s Crypto Network
