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LearnAcademyInvestment fundamentals: Strategies in practiceLesson 6: The Essential Role of Diversification

Lesson 6: The Essential Role of Diversification

After completing this lesson, you will be able to:
Understand what portfolio diversification is.
Identify the benefits of diversification.
Explain how diversification minimizes risk.
Understand the role of crypto in an overall investment plan.
Make a simple asset allocation plan.

Welcome to the sixth lesson in Kriptomat’s guide to fundamental investment strategies. In this lesson, we’ll focus on the how and why of portfolio diversification.

Portfolio diversification is a financial strategy based on building variety in your investment plan.

  • For example, you might mix large-cap and small-cap cryptocurrencies.
  • You could include a mix of cryptos associated with DeFi (decentralized finance), NFTs (non-fungible tokens), and games.
  • Your mix could include cryptos that you’re holding long-term to meet major financial goals and cryptos that you’re buying in hopes of scoring a quick profit.
  • Broadly speaking, your portfolio includes all your investments, so it could also include traditional stocks, index funds, real estate, and other investments. Confident investors average 10 or more cryptocurrencies in their portfolios.

Financial experts recommend diversification as a way of minimizing the risks of investing

  • Because price changes can’t be predicted perfectly, all investing includes risks.
  • Some investing risks are unavoidable. Inflation rates can erode the value of your portfolio. Interest rates can reduce the value of fixed-rate investments. Currency exchange rates can deflate the value of overseas investments.
  • Other risks can be avoided or minimized. These include losing money by investing in a DeFi project that fails, investing in a market segment that experiences a downturn, or buying currency so volatile the value of your portfolio changes too fast to make a sensible financial plan.

Diversification also positions you to benefit from big price jumps that affect more cryptocurrencies.

  • If your portfolio holds just one or two cryptos, you profit only when those crypto prices rise.
  • The more cryptos you own, the more opportunities you have to profit – and the higher the odds you’ll share in profits from the market’s best and fastest gainers.

Diversification spreads out and dilutes the risks.

  • Your portfolio won’t lose all its value in an NFT downturn if it also includes DeFi and gaming tokens.
  • If you’re invested in multiple cryptocurrencies, a hack or scandal causing the price of a single crypto to plummet will have a minimal effect on your portfolio’s overall value.
  • The idea is that losses in one part of your portfolio don’t affect other parts, which may be seeing rising prices.

Your diversification plan may include more than crypto

  • A financial plan includes cost control, savings, and investments. Your savings and investments might be part crypto and part traditional.
  • For example, you might keep the savings account at your bank while adding crypto staking or a KriptoEarn wallet, which delivers up to 13.5% APY on your crypto balance.
  • In addition to investing in cryptocurrencies, you might allocate part of your portfolio to index funds, government bonds, real estate, and other investment options.
  • Many financial managers now recommend that investors reserve a portion of their portfolios for Bitcoin and other cryptocurrencies. In a 2022 Forbes survey of 65 billionaires, 30% disclosed that their portfolios included a cryptocurrency component.

You can make your own asset allocation plan in a few minutes

  • Start by listing your current investments.
  • Categorize your investments as high or low risk, large or small market cap, crypto or traditional, and market segment.
  • Keep in mind the risk and growth potential of each element of your portfolio according to your investing goals.
  • If your investment plans include long-term goals like funding retirement or buying a home, you’ll want to allocate more of your portfolio to risk-minimizing long-term strategies like cost averaging.
  • Your asset allocation plan tells you which kinds of assets you should buy to achieve your ideal portfolio diversification profile.

So – what did we learn?

  • Diversification can minimize the risk of missing out by including more cryptos in your portfolio – including, potentially, one whose price rockets.
  • Diversification also minimizes the risk of big losses from investing most or all of your portfolio in a single crypto that plummets in price.
  • Experts advise holding at least 10 cryptos in your portfolio.

That’s the end of this lesson! Test your understanding and earn points toward a Kriptomat Academy certificate of achievement by taking the test!

What is portfolio diversification?

A way of ensuring your crypto is supported by teams of different faiths, nationalities, genders, and ethnic backgrounds.
A way of ensuring that your portfolio always includes the top gainers no matter whether you’re in a bull or bear market.
A bogus goal promoted by pricey financial advisors to increase their fees by multiplying the number of assets they manage.
A strategy for minimizing the risks of investing.

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What is a potential weakness of portfolio diversification?

You miss maximum returns if one particular cryptocurrency explodes in value.
Diversification takes authority for deciding upon investments out of the investor’s hands.
Diversified portfolios are subject to special taxes on capital gains.
A large portfolio could grow beyond the capacity of your crypto wallet.

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Which of these statements is NOT a way crypto could fit into a diversified investment plan?

The portfolio could be 100% crypto as long as the cryptocurrencies in the portfolio are diverse.
Crypto could provide the high-risk, high-yield component of a diverse portfolio whose other elements are safe, low-yield government bonds.
Crypto could provide an easy, legal way to move other assets out of government-supervised currencies and banks, thus reducing tax liability.
A diversified portfolio could include large-cap and small-cap cryptos, older coins, and tokens associated with innovative new technologies.

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Which of these conditions is essential if diversification is to reduce investing risk?

Diversification must include different classes of assets, including crypto, NFTs, stocks, bonds, and real estate.
The diversified portfolio must hold cryptocurrencies that were created in geographically diverse cities, countries, and continents.
The diversified portfolio must include assets whose prices respond differently to the same market conditions.
The rationale for your diverse asset allocation plan must remain.

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Which of these is NOT an essential step for building a diversified asset allocation plan?

Categorize your current investments.
Determine the risks and returns you need from your portfolio.
List your current investments.
Be sure to include clothing, furniture, and other property that could be liquidated quickly and converted to cash if necessary.

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Kriptomat Academy content is informative in nature and should not be considered a personalised or any other investment recommendations or advice.
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