Having a balanced portfolio is something very important that all investors should pay attention to. Investors should focus on their goals and work in order to create a balanced portfolio that would be able to reflect their needs.
Some portfolios can be riskier than others. Indeed, each portfolio would require investors to analyse their risk, plan their strategies and determine the best asset allocation to meet their needs. Balanced portfolios are also important in the cryptocurrency market.
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In this post, we share with you the importance of having a balanced portfolio and how to build one.
Why is it Important to Have a Balanced Portfolio?
Investors that try to build an investment portfolio should know that it is very important to have balanced investments. There are some ways in which you can build a balanced portfolio with different assets that would fit your investment strategy and risk aversion.
Making a successful portfolio also requires patience and analysis. You should remember that when you build your portfolio you are basically choosing those assets that you believe could perform well or that would not perform that bad if the market turns bearish.
If you have a portfolio that is not balanced (you invest everything in just one type of assets), then you could negatively be affected if the industry that you invested in falls. That would not only create a negative situation for your finances, but it would also mean that you lost possible gains from other types of investments.
Having a balanced portfolio would be very important as it would let you get exposure to volatile assets that could generate large profits, but it would also let you protect your portfolio in case those assets enter a bear market or start falling.
Basically, building a decentralized portfolio is important because you would find a hedge in case the assets you thought were going to give you large winnings move on the contrary direction. There are many ways in which you can hedge your investments and still participate in the market.
In this way, the more balanced your portfolio is, the lowest the chances are that you would have a negative result. Despite that, you are also reducing your earnings just to be hedged in case things do not go in the direction you were expecting.
How to Build a Balanced Portfolio?
This brings us to the question of how to build a balanced portfolio. You need to take into consideration some things before you start with it. We are talking about the funds that you want to invest in, the assets that you think would register large gains and analyzing your risk tolerance, among other things. This is not an easy task, as it requires investigation, time, and effort. Let’s get into the details that would let us create some of the most profitable and diversified portfolios in the cryptocurrency market.
Find Potentially Disruptive Assets
The first thing you need to do is find potentially disruptive assets. These assets would usually be very helpful for you to make a profit if you create a balanced investment portfolio. In addition, you would have to make a clear analysis of the assets you are investing in. This is very important as you would be deciding where to invest in.
These assets would also be very volatile. Thus, you might want to take that into consideration when investing in these types of assets. Your investment in this part of your portfolio would be the one that would decide whether you make a profit or if your hedge should be activated or not.
Selecting the right disruptive asset is not an easy task. How can we know which is going to be the next virtual currency to move higher? This is something that we cannot predict. This is why, in many cases, investors would allocate a small percentage of their funds to these risk assets.
It is not possible to know whether they will grow or not until that happens. Of course, there are some projects that would be more reliable than others, but there is no clear rule on how to assess these investments. The assessment should be done independently or through a third-party company that will share valuable information with the investor in order to build a diversified portfolio.
As we mentioned before, a few of these assets would then expand and grow throughout the year. However, a small allocation to one of these assets could make a large difference at the end of the year.
Decide your Investment Allocation
When creating a balanced portfolio, we should also analyse which is going to be our allocation of funds. Investing larger amounts of money would also involve higher risk. This would depend on the type of investor that you are and how much risk you are able to support.
Usually, investors find a point somewhere in the middle, not very risky but also not extremely conservative. In the end, the goal is for our portfolio to generate a profit.
Conservative investments are usually the largest. This would provide stability to your portfolio with the expectation of being able to generate a small return to your investment. Meanwhile, riskier assets would then have a smaller allocation percentage.
As we mentioned in the previous section, the riskier the asset, the smaller the percentage allocation on them. Additionally, to have an even more diversified portfolio in the cryptocurrency market, the best thing that we can do is to also search for diversification across investment sections.
For example, if we decided to create a portfolio with a 70% low-risk allocation, 25% medium-risk allocation and 5% high-risk allocation, the assets that we buy for each category would not represent 100% of each of them. The 5% risk allocation can be divided with a sub-allocation of 70% of ICOs, 20% IFOs and 10% IEOs. The same applies to all the other sections and segments of our portfolio.
Deciding and analyzing the investment that you would make requires you to check and understand which are the possible assets, cryptocurrencies and other assets that you could purchase. You should always make a list of the options that you have available and make a decision on how to split your investments.
Search for a Hedge
It is also important to search for a hedge. This is going to be the asset that would help you if your main risk asset falls. Although it might not be able to generate a profit for you, it could be the one that softens your losses during years in which your portfolio performs poorly.
Low-risk assets are always a good idea if you are planning to have a diversified portfolio. Usually, these low-risk assets become the largest part of your portfolio as they would protect your investment from getting lost if there is a bear market.
These assets would not let you make a large profit. During bull markets, they would behave positively but would simply give you a very small profit. Therefore, you need to mix these hedge assets with other higher-risk investments.
When the market behaves sideways, these low-risk assets should also remain positive. That means that you would be able to stay positive even if the market trend is not so clear. Now, when it comes to a bear trend, there are some things that we should consider.
For example, we should know that if there is a bear trend, we might see our portfolio move downwards. However, when we have a good allocation of hedge assets, we could still remain positive or offset the losses of high-risk assets (which are usually the first assets to fall during bear markets).
That being said, building a portfolio requires care and investigation. Following the cryptocurrency market and analyzing it on a regular basis would give you a clear idea of which things we should take into consideration when creating and building our investment portfolios.
Stablecoins as a Hedge and Low-Risk Investments
It is also possible to create portfolios that would let investors use stablecoins. Thanks to their lack of price fluctuation, they could be considered as cash equivalents (but there are some differences between holding cash and stablecoins).
By using stablecoins, users could invest their funds in different decentralized finance (DeFi) protocols or platforms in order to get a profit. However, if this is one of the strategies used for the low-risk allocation, then there is something else that we should take into consideration.
Despite the fact that we are using low-risk assets such as stablecoins, we should also know that there are some risks associated with DeFi investments. For example, when we engage on different investments related to DeFi and we interact with smart contracts, despite using stablecoins, we have other risks such as smart contract risks.
Usually, when we talk about smart contract risk, we think about the possibility of the smart contract failing and being attacked or hacked. This could create a situation in which the low-risk part of the portfolio ends up generating a higher risk to the investor. Therefore, it is always very important to make sure that the risk remains low, even if that means that there will be fewer rewards to investors or that it would generate a lower profit.
If we want to increase our risk, then this should be considered a medium-risk investment. This would help us reduce our total risk and have a balanced portfolio.
Rebalancing Your Portfolio
In finance, a portfolio is said to be actively or passively rebalanced when it is reconfigured so that its weighting in each asset class approaches an original target allocation. Portfolio rebalancing helps to maintain target allocations and reduce the risk of being too exposed to any particular asset class.
Rebalancing is important as investment markets change over time because they can move away from their original allocation targets due to factors like changes in interest rates, investment performance, new fund offerings and fee structures, and investor withdrawals.
Portfolio rebalancing is commonly done via the following types of transactions:
The most common way for a portfolio to be reconfigured is by selling securities that have grown in value and buying securities that have declined in value. In a well-designed portfolio, this type of transaction should result in the overall portfolio weightings as well as each security being replaced by similar security of equal or similar risk.
A cash account, or cash reserve, is a reserve asset within a portfolio consisting of money that is used as a safety net in case the portfolio falls short of its investment goal. For example, an investor may wish to have an additional $50,000 deposited in his portfolio each year. In order to do this, the investor would buy $50,000 worth of stock with his portfolio cash balance.
A “cash drag” refers to the tendency of money markets to under-perform other types of investments. The cash drag is the result of investors preferring to place their money in money market accounts than in other less secure, but potentially higher performing assets.
In general, when a portfolio is purchased it has a different “risk profile” than it will have at any later date. This is because different holdings will have gained or lost value and new holdings may have been added to the portfolio.
When it comes to cryptocurrencies, investors can simply have a part of their portfolio denominated in stablecoins. Stablecoins are digital currencies that do not fluctuate in value as it could happen with Bitcoin (BTC) or other virtual currencies. Stablecoins can be invested in different DeFi protocols or being held in a secure hardware wallet in order to use them in case they are needed.
When rebalancing a portfolio, investors could have a small part of their funds in stablecoins ready to be used at any time. Being fast and ready to react is also a very important thing when managing a portfolio.
Having and creating a balanced portfolio is not an easy thing. It requires investors to know the market in which they are investing and the assets that they are purchasing. It would also be very important for investors to understand how rebalancing a portfolio works and why it matters to the overall success of the portfolio.
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