If you are thinking about incorporating Bitcoin, Ethereum and other cryptocurrencies into your investment portfolio, you are certainly not alone. As the price of Bitcoin surged past even the most optimistic predictions, the largest cryptocurrency exchange reported that more than 100,000 new accounts were opened over a single weekend.
That is a lot of new accounts, and a lot of new investors. But just what role should cryptocurrency play in your investment portfolio, and how can you protect yourself from the potential downside?
Despite its meteoric rise, the cryptocurrency market is still new and relatively untested. For every upside prediction, there is another prediction that claims the cryptocurrency market is nothing but a bubble – one that will eventually pop and take billions of dollars worth of value with it. If you want to jump into this growing market, feel free to, but make your move with your eyes wide open. Here are some smart ways to manage the risk of the cryptocurrency market while maximizing your returns.
Spread the Risk With a Diversified Portfolio
While Bitcoin and Ethereum are getting the bulk of the press, there are literally hundreds of other cryptocurrencies on the worldwide market. Many of these alternative cryptocurrencies, collectively known as altcoins, have also been making new highs, while others have languished at just pennies a coin.
Just as buying a basket of stocks is less risky than buying a single company, putting together a portfolio consisting of dozens, or even hundreds, of altcoins could limit the risk of cryptocurrency investing. Unfortunately, building such a portfolio can be challenging, since many major exchanges limit sales and purchases to a handful of relatively well-known cryptocurrencies.
Make Volatility Your Friend With a Dollar Cost Average Approach
If you participate in your 401(k) at work or invest in mutual funds, you may be familiar with dollar cost averaging. Long a staple of the investment industry, dollar cost averaging simply means buying an asset over time – instead of investing a $1,200 lump sum in your favorite mutual fund, you spread the risk by putting in $100 a month.
You can do the same when investing in cryptocurrencies, and this approach could partially shield you from sudden drops in value and wild swings in price. Many exchanges allow you to link your bank account and invest a set amount on a monthly, weekly or even daily basis. Keep in mind that the extreme volatility of the cryptocurrency market can reduce the efficiency of dollar cost averaging, but this kind of approach could still limit your risk.
Do Your Homework and Understand Your Storage Options
Investing in Bitcoin and other cryptocurrencies is not the same as depositing money in the bank. The decentralized nature of Bitcoin transactions and storage has its advantages, but it also makes it nearly impossible to undo a fraudulent or unauthorized transaction.
If you plan to leave your cryptocurrency with an exchange, the quality, insurance coverage and track record of that exchange will be critical. If you plan to keep your coins in a hardware or software wallet, the security of your computer, the quality of your passwords and your own memory could make or break your investment. Many cryptocurrency investors have been tripped up by things like hard drive crashes, computers with malware and simply forgetting their passwords.
Get Advice About Taxes
There are a lot of things still up in the air about the cryptocurrency market, including the impact of taxes. While the IRS has provided some guidance on how it views Bitcoin and other cryptocurrencies, a lot remains unknown.
If you do make it big in the cryptocurrency market and make a lot of money, you will need to understand the impact of taxes. If you fail to report the transactions, you risk the ire of the IRS, something no investor wants to deal with. At this point, there are not a lot of tax experts who specialize in cryptocurrency transactions, but you would be wise to seek one out.
Only Put in Money You Can Afford to Lose
Last but not least, the most important thing to keep in mind is that Bitcoin and other cryptocurrencies could go to zero overnight. No one, not the inventor of Bitcoin, not your investment advisor and not the most knowledgeable Wall Street expert, really knows what Bitcoin is worth.
Before you invest a single penny in the cryptocurrency market, you need to decide how much you are willing to lose. This amount will be different for every investor, so this is a highly personal decision. Whether you decide to invest $100, $1,000, 1% or 10% of your portfolio, investing with money you can afford to lose is the best way to limit your risk.
Many investment professionals advise their clients to think of cryptocurrency as a speculation, and some even liken it to a trip to Vegas. If you take this approach, you can limit your risk while still preserving the enormous upside some cryptocurrency fans predict.