I once had an economics professor tell me, “The principle behind investing is to keep your risks mitigated while giving yourself the biggest returns.”
Sound advice? Sure.
Simple enough? Absolutely.
I’ve carried this advice with me my entire professional life. But is there more than meets the eye? Does it pass the so-called whiff test?
Well, I recently wrote about the number one factor that effects market returns; Asset Allocation. But setting your allocations can only happen if you are aware of your risk tolerance. In short, how much percent loss of your portfolio can you stomach before hitting the panic button? Once, that threshold is identified and your asset allocation set, then the next obvious step is to continue to mitigate your future risk.
So what mitigates risk for an individual investor?
Simply put, Time and Diversification. Now time is the easy part, and I’ve written on this as well. Did you know that no 20-year block of time in market history has ever seen a losing outcome? If you wish to extrapolate this to the crypto-verse, go right ahead. The blockchain is going nowhere. I believe this technology is a game changer and here to stay.
So let’s expound a bit on diversification. This has been a hot topic the last couple days based on recent posts in the crypto-sphere. Not so much how diversification helps, but how over-diversification harms.
In fact, over-diversification has become such an investor bugaboo, that Peter Lynch coined the term ‘DIWORSIFICATION‘, lamenting the fact that some companies expand into areas widely different from their core business. For some knee-jerk examples, look no further than Under Armour or GoPro. This especially applies to personal investors, as most large companies have consortiums of people, a lot smarter then we, acting as safeguards. For the average investor, the entire free market is at your fingertips. And more often then not, that is a bad thing.
An old memo written by ex-Yahoo senior vice president Brad Garlinghouse, since been dubbed the “Peanut Butter Manifesto” — leaked to The Wall Street Journal, lamented that the company “lacks a focused, cohesive vision…. I’ve heard our strategy described as spreading peanut butter across the myriad opportunities that continue to evolve in the online world. The result: a thin layer of investment spread across everything we do and thus we focus on nothing in particular.” This is a shinning example of why personal investors such as WE need to be cognizant of ‘diworsification’.
Now with that giant disclaimer behind us, diversification remains the single best way to mitigate your investment risk. Don’t believe me? Ask the folks who were all-in on Enron or Lehman Brothers. The main mistake I see amateur crypto investors do is simply gobbling up coins like a raccoon in a garbage can, and think they are diversified. That couldn’t be further from the truth. To be truly diversified, redundancy is a no-no. A portfolio of 4 coins can be just as diversified (or more) as one with 30 coins. Being spread out across both market cap and industry sectors is crucial.
But how much is too much?
That is the golden question. And honestly, this is up to the individual. It may come down to really how much time you wish to invest in this digital crack habit. If 10 coins exceeds your tolerance of fundamental analysis (FA), then stop there. But wisely choose investments that are spread-out as described above. Even focusing on one industry, but spread across the market cap probably is enough.
Granted, I wrote the majority of this piece during the Bitcoin bull-market of late 2017. As of this updated writing, the current sate of the crypto market is down. It is said that capitulation is upon us and that hyper-Bitcoinization will pave the way for the bad actors to bow out of the next scene. The so-called Bitcoin Maximalists are currently standing tall, shoulders straight, and noses high. We have just seen 20 billion dollars of total market cap leave the space in a blink.
Is it finally time to consolidate?
Is ‘diworsification’ now defined as holding anything but Bitcoin?
I don’t think anyone truly knows that answer. Personally, my portfolio still exceeds 30 coins. Yet, do I feel I’ve slipped into ‘diworsification’?
No, not yet.
My risk tolerance that I calculated as discussed above is currently at a high-water mark. Maybe it’s my experience as an equity investor that precludes any concern for that. But what I do know, is that my investments are well spread across the crypto landscape. Not done haphazardly, but with much deliberation.
Am I running the risk that my investments could turn to dust? Yes. I mean I must own some of those bad actors, surely. But if you’ve followed my verbal diarrhea from the start, you all should know that I never risk more than I can comfortably loose in a blink. With that said, my primary retirement portfolio remains on auto-pilot, confidently dollar-cost average investing into a strong core of basic index funds. This is my soft feathery pillow I use to fall asleep at night.
There will come a time when the law of diminishing returns applies, whether it’s directly from the bad actors exiting stage left, or by hyper-Bitcoinization truly coming to fruition. But personally, I feel that it’s not a cliff we all just suddenly jump off. But it’s more a limit of comfort that is to each your own. Once you’re outside your comfort level, that’s when stupid mistakes happen and diminishing returns occur. So my final advice when you’re not sure what to do next is simply to stay in your lane.
So sleep on that CryptogleHeads and Cryptogle On!