Capital at risk. This information is not investment advice. Security values can go up as well as down. Past performance is not indicative of future results.
When heading off for your summer holiday, how do you pack - just clothes for the season? Or do you include a jacket in case the weather surprises you? It’s no different when it comes to investing and constructing your portfolio. Diversification, or ensuring you’re prepared for a wide range of environments, is considered a time-tested investment strategy that is said to help reduce risk and may increase your returns. What are the benefits of diversification, and how could it be achieved with your hard-earned cash via stocks and the crypto market?
Why diversify?
There are three good reasons to diversify a portfolio:
- Lowering risk: By diversifying your investments across a range of asset classes, such as cryptocurrencies and S&P 100 stocks, you spread out risk. If one of the asset classes fails to perform, another might outperform, hence cushioning the blow.
- Reducing volatility: Volatility refers to how much and how quickly prices for a particular asset move over a given span of time. Increased volatility is frequently a sign of fear and uncertainty among investors. The VIX, or volatility index, is sometimes referred to as the “fear index”. A diversified portfolio, depending on what is held, could help smooth out volatility, potentially making it less sensitive to market turbulence. For example, if you were to compare two portfolios acquired in August 2021 – one consisting solely of Bitcoin and the other comprising an equal distribution of assets across Bitcoin, S&P 500, 10-Year Treasury Bonds, a Commodities Index and Real Estate – you’d notice that over a one-year period, the diversified portfolio exhibited reduced volatility and yielded a higher return.
- Reaching investment goals: Diversification won’t guarantee higher returns. However, it does allow the incorporation of a wider range of assets to achieve a variety of investment goals, from income generation to hedging against inflation. Haul out your inflation calculator and you’ll quickly see that historically cash, for example, has not proved to be a great investment for building wealth. But cash, specifically hard currencies, is good for an emergency savings fund, or if your child is heading to college. In essence, different investment goals require a different range of diversified assets.
Let’s look at two key assets that have historically helped build a resilient investment portfolio.
Diversifying in stocks
Stocks are often a cornerstone of any portfolio and one of the key ways of combating inflation by offering a higher rate of return over an extended period of time. For example, over ten-year periods, stocks have offered higher returns— in general, an average annual return of 9-10%— compared with most other asset classes. This means that a $10,000 investment compounded at 10% for 30 years would grow to nearly $175,000. In fact, the S&P 500 has, over the past two decades, returned 590% — including stock price gains, plus dividends—despite some punishing market conditions. The S&P 100 has an annualised return of 10.25% over the past 10 years. This outperforms the S&P 500, with its annualised return of 9.64%.
Within a stock portfolio, you might consider diversification in several ways, such as according to sector, company size or dividend redistribution. Remember, when you hold stocks, you have a stake in a business. If it’s the S&P 500, then you are essentially investing in the top 500 American businesses - a hedge against many exchange rates in poorer countries.
However, stocks are not risk-free, and even the share price of stable companies can fluctuate dramatically over shorter periods of time. The S&P 500 has declined by 20% or more in 12 different periods since 1950. The average length of a market crash is 342 days, with an average stock market decline of -33.38%. With this in mind, it’s vital to allocate assets appropriately for long-term investment. An asset allocation strategy we’ve come across is to subtract your age from 110 to determine the percentage of your portfolio that should be stocks - for example, a 45-year-old would have approximately 65% invested in stocks.
Diversifying in crypto
Crypto offers high growth potential. For instance, consider the graph below, illustrating the growth in the price of Ethereum in US dollars since August 2015. This presents an opportunity to diversify away from traditional financial assets, but it is not without risk. Depending on an investor’s knowledge, risk appetite and financial goals, crypto can constitute a small or substantial portion of a responsible investment portfolio.
When it comes to structuring your cryptocurrency portfolio, there are several popular approaches that can appeal to investors. To begin, some investors prefer diversifying their holdings by including various tokens or coins across different blockchains and crypto use cases, such as decentralised finance (DeFi), gaming, privacy, the metaverse, and more. Bear in mind that Bitcoin is the largest and currently most valuable cryptocurrency, followed by Ethereum. Therefore, it’s important to carefully consider how much of these assets you want to include in your portfolio.
Some other popular blockchains to consider include Polygon (MATIC), a layer-2 solution crafted to scale and improve the functionality of the Ethereum network, and Cardano (ADA), a decentralised proof of stake (PoS) blockchain engineered to work more efficiently than a proof of work (PoW) network like Bitcoin. PoS and PoW refer to the way new blocks of transactions are validated and rewarded in the blockchain.
Rebalancing is a vital part of maintaining a diversified cryptocurrency portfolio. For example, if some of your smaller coins increase substantially, you may want to sell them or trade them for larger cryptocurrencies or stablecoins.
A diversified investment portfolio, whether you’re considering stocks, cryptocurrencies, or a combination of both, could offer a way to protect your investment from market fluctuations and, all going well, to enhance returns in the long term.
Disclaimer
This article is for general information purposes only and is not intended to constitute legal or other professional advice or a recommendation of any kind whatsoever and should not be relied upon or treated as a substitute for specific advice relevant to particular circumstances. We make no warranties, representations or undertakings about any of the content of this article (including, without limitation, as to the quality, accuracy, completeness or fitness for any particular purpose of such content), or any content of any other material referred to or accessed by hyperlinks through this article. We make no representations, warranties or guarantees, whether express or implied, that the content on our site is accurate, complete or up-to-date.
Eligible fiat deposits are protected by the Gibraltar Deposit Guarantee Scheme up to a maximum of the US Dollar equivalent of EUR 100,000 (subject to prevailing exchange rates on the compensation date).
Capital at risk. This information is not investment advice. Security values can go up as well as down. Past performance is not indicative of future results.
