According to a recent GOBankingRates survey, around a quarter of people invest in digital currencies. This alone makes cryptocurrencies worth studying, as it represents a lot of money entering 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 are usually quoted continuously throughout the day. Big winners, like the stunning return of Shiba Inu in 2021, are also making headlines.
But should digital currencies really be part of your investment portfolio? Here are the reasons why some experts think so.
The fundamental objective of investment diversification is to limit risk. As cryptocurrencies are extremely volatile, it pays to diversify this risk with more traditional investments like stocks and bonds. But the opposite is also true.
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According to Michael Kelly, CFA at Switchback Financial, “I consider (cryptocurrency) a valid asset class in a portfolio because of its lack of correlation with traditional stock and bond investments.” Kelly sees crypto as a potential opportunity, but he still limits client exposure to a 1-2% allocation.
Cathie Wood, CEO of Ark Investment Management, goes one step further when it comes to the potential benefits of cryptocurrency diversification, telling CNBC that it’s the “holy grail of diversification.” According to Wood, “institutional managers need to look at new asset classes that are moving and have low correlations.”
Anjali Jariwala, founder of FIT Advisors, suggests that you should diversify more even within your crypto allocation. According to Jariwala, the real benefit of diversifying into cryptocurrency is to limit extreme outcomes. If one cryptocurrency fails and your investment drops to zero, other crypto investments can still do well. Ideally, says Jariwala, your entire crypto portfolio won’t be wiped out because of a single coin.
In addition to avoiding a total loss on your portfolio, diversifying your portfolio with crypto can help your overall upside. 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 cryptocurrency will not only smooth the ups and downs of the class d ‘volatile assets, but also potentially juice. your total returns.
As most cryptos got hammered in price in the middle of 2022, this could present a buying opportunity for risk-averse long-term investors. If you diversify your portfolio properly by not being too overexposed to crypto, even a large loss won’t take more than a few percentage points off your portfolio’s total return.
Cryptocurrency bulls see the sky as the limit for crypto. As Wood told CNBC, “Institutional investors switching to Bitcoin could add $500,000 to its price, if they eventually give it a 5% allocation.”
There’s no denying that the potential for cryptocurrency to change the very nature of financial systems in the future is exciting. However, since this asset class was essentially created from scratch and remains a whole new way to invest, it also carries immense risks. Here are some of those risks:
Crypto is still speculation
The bottom line is that for all the excitement that crypto brings to the investment world, it is mostly driven by the hopes and dreams of its investors. Although some cryptos have real-world functionality, they are not backed by revenue or earnings like stocks are. Instead, investors back currencies that they believe will evolve into something bigger or will simply be pushed higher by mobs of speculators.
To help reduce this risk, stick with the big names in space. According to Anastasiya Belyaeva, Head of Growth at PieDAO, a platform that offers investors a range of crypto wallets, “If you are a new investor, bet on coins and projects that have been around for a while and have proven that they’re at least not a scam is a good idea,” Belyaeva said. “Investing in something that’s been around for a few weeks is probably risky for new investors.”
Crypto is very volatile
Even though some cryptos turn out to be “the next big thing”, as an overall asset class they are extremely volatile. In early May 2022, for example, the stablecoin Terra, which was supposed to maintain an equivalent value of $1, fell off a cliff and fell to just 9 cents per coin. This sent a huge ripple through the entire crypto world, wiping out $200 billion worth of cryptocurrencies from around the world in a single day, according to CNBC.
When so-called “stable” coins can crash 91% — and former big winners like Shiba Inu can drop 87% from their all-time highs — you need to be prepared to handle huge swings in your portfolio. . For many investors, that’s just too much to bear.
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