Don't put all your cryptos in one wallet - Why diversifying will give you less stress and more gains
Updated: Jul 16, 2019
Too often do I see people that hold only a few or even just one crypto/s, and even worse, only hold cryptos in their portfolio.
Don't put all your eggs in one basket! Or, to adapt the old saying better to this time and space, "don't put all your cryptos in one wallet!" What happens if you loose the key? What happens if that hard drive brakes?
We have touched on diversification before but I believe that this is probably the simplest and one of the most effective ways to increase your investment returns over time. Thus a deep dive on the subject seems warranted.
Diversification, in investing, means to spread your investments over different asset classes and assets within each asset class. The point of doing this, originally, is to avoid having all your wealth depend on one single market/industry/asset class, as that would make your wealth very sensitive to that particular market/industry/asset. Now, some people may think "This is only good! The more exposed I am to this market the more my wealth will increase with it!".
And that is true. If all your wealth is in BTC and it doubles in price, so will your wealth. If you had 50% in cash and 50% in BTC, and BTC doubles in price your total wealth would only increase by 50%.
So what is the problem? If you have done your research you should know if an asset will go up and in that case you should have all your wealth in that asset.
Well, the problem here is firstly that humans (and yes that includes you reading this) are not perfect. We can percieve and understand things incorrectly, both because our research is not adequate and because we misunderstand our research. The human brain is evolved to survive on a savannah, not to analyse assets and try to make wealth grow. So, the first problem of non-diversification is that your beliefs do not always correspond with reality
There are countless of studies on this, just look at the research of Daniel Kahneman who won the nobel prize in economics for proving that people are irrational. I recomend reading his book "Thinking fast and slow", as he really shows just how irrational us humans are.
Furthermore, according to the study Trading Is Hazardous to Wealth: The Common Investment Performance of Individual Investors, on average, the more active an investor is (the more buys and sells he/she makes) the less ROI he/she recieves. To read more studies confirming the incompetence of individual investor decisions compared to investing based on a clear system or index, you can read here: https://www.ifa.com/articles/summary_of_academic_research_on_stock_picking/
The second problem of not diversifying is that even if your analysis manages to find the most probable outcome, it is only the most probable outcome, not the guaranteed outcome. There is always a chance of the less probable events happening. Just look at PRL, it was a great idea with a growing community and active developers. The PRL token was fundementaly undervalued as it was pegged to 64GB of cloud storage, which was worth much more than the token. Still, the founder and ex CEO went insane (litteraly) and thought that the worlds nations was keeping the oil price up and that it would soon crash, and with it, the whole world as we know it. Followingly, he exploited his own protocol, sold all his holdings, left the project and dissapeared. One of the projects tokens is completely gone and the other is now replaced by OPQ which has a lot lower price than PRL had. That is not really something you can uncover in advance by doing research on a project.
This is the reason why it is unwise to rely on one or few investment decissions, which you are doing when you are not diversified. What you can do to combat the possible faults in your analysis is to start relying on your average investment decission instead.
Say you are a moderatley good investor (which you should learn to become before investing larger sums), and your average success rate of each investment, over a year, is around 60%. Assuming each winning investment returns 10%, over a year, and each loosing one creates a loss of 10%, over a year, an investment of 1000$ spread across 10 cryptos should net you a 2% ROI. It is not much, but your winning investments probably return more than 10 %, and still it is a positive return.
If you would invest the same 1000$ in one crypto and the assumptions remain the same you have a 60% chance of gaining 10% and a 40% chance of loosing 10%, over a year. High risk, high reward, as they say. Yes, it is true that this provides a better return if it is a winning investment, but the same can be said for lottery tickets.
However, looking over 10 years, you would have a 2% return each year in the first example, and in the second you would have 6 winning years and 4 loosing ones. The diversified portfolio would net you a 22% return. while the non diversified would, most likely, leave you with a little more than 16% return. This disparity would only increase with time. That said, the non diversified portfolio has a chance of only having winning years, and would in that case return much more. But knowing the odds, and betting on the non diversified portfolio is not investing, that is speculative gambling.
Other than my calculations above, diversification has also been proven to decrease risks while not sacrificing expected return, over the long term. The most famous proof of this is probably Modern Portfolio Theory developed by Harry Markovitz who actually won The Nobel Prize for that theory.
Alright, alright... Percentages and Markovitzes in all honor, but where do I want to go with all this?
I want you to think the next time your research shows you 10 different cryptos with potential for good ROI. Don't just choose the best of them and ignore the rest, invest in all of them. As long as your analysis and investment decision is good on average, a diversified portfolio should have higher returns, in the long run, than a non diversified portfolio. And it will definitely experience less volatility, and give you less stress.
To get some inspiration on how to build your crypto portfolio and find investments you can read my other article here: thedecrypter.com
/Alex - The Decrypter.
Note: Invest at your own risk and always make sure to research your investments thoroughly.