The correct way to diversify

Many people have too many bags” -Cryptonary-

Over-diversifying is just as bad as not diversifying at all.

Diversification

The concept of diversification can be summarised by the saying: “Don’t put all your eggs in one basket”. The reason is simple, it reduces risk. When you have all of your capital in one asset, you’re holding asset-specific risk. This means if the entire market is on the rise but the specific asset you hold is hit by bad news, you’ll witness losses while the remainder of the market witnesses gains. The worse thing that can happen is complete project shutdown, in which case your capital is as good as gone.

While the odds of such events happening are quite small, they still statistically exist. Which is why diversifying is a good way to lower risk as well as have a wider chance at hitting a home run.

Over-Diversification

If you become too worried about not “hitting a home run”, the human tendency is to gather way too many bags (i.e. investing in too many assets). This reduces your potential returns too because when one of the assets you own inevitably does hit a home run, your allocation to it was not significant enough for it to make an actual change.

The issue here is a lack of conviction, when an investor has conviction they’ll choose a few assets and allocate a good chunk of capital to them. Research builds conviction and proper research increases the odds of hitting a home run.

Optimal Diversification

Personally, we do not hold more than 10 assets in our main portfolio at any time. Up to 20 assets is within reason but reaches the extremities. The only exception is for very large capital owners (8-9 figures+) in which case liquidity in certain assets is their upper limit and they need to go above the 20 number.

The lower the number of assets invested in, the more attention each project can be given. No single human is physically capable of fully keeping up to date with 50 projects at a time which means they might miss signs of trouble, signs of “jump off the ship”.

Low-Risk Diversification

Diversification in the traditional sense has more to do with diversifying between assets that have negative correlations (when on rises, the other falls). However, we assume here that crypto-investors accept the risk of this market and are not particularly looking for this sort of low-risk diversification; which doesn’t exist without derivatives in crypto yet as it remains a rather small market ruled by Bitcoin.

 

Less is more

 

Disclaimer: NOT FINANCIAL NOR INVESTMENT ADVICE. Only you are responsible for any capital-related decisions you make and only you are accountable for the results.

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