Before plunging into the investment world, diversification is one of the basic terms to know and understand. Diversification is a powerful strategy to reduce the level of losses that investors can experience.
In crypto investing, the meaning of diversification is dividing the investment into various types of crypto and other digital assets so that they don’t just depend on a single asset.
Diversification is important in crypto investing because it can help reduce the risks associated with investing in crypto. With diversification, crypto investors can take advantage of growth opportunities from various projects and types of digital assets.
In the crypto context, volatility can result in sharp and unpredictable price changes in digital assets. To deal with this volatility and risk, it is important to have a mature and disciplined investment strategy, one of which is diversification.
So, consider the following review to understand better what diversification is, its benefits in investing, how it works, and the types, advantages, and disadvantages.
What is Diversification?
In the context of investment in general, diversification is a strategy carried out by investors by dividing/distributing their investment funds into different types of assets or financial instruments.
Meanwhile, diversification aims to reduce risk and increase profit potential in the investment portfolio.
As for the context of investing in the crypto world, diversification refers to dividing investment funds into various types of crypto and other digital assets. For example, investors can divide their investment funds into Bitcoin assets, Ethereum, etc.
The main purpose of diversification in investment, namely to reduce risk and increase the potential profit in the investment portfolio. Diversification also helps reduce the risk associated with overall market fluctuations.
In this case, when investors divide their investments across different types of assets, they will reduce the risk associated with sharp and unexpected price fluctuations in a particular asset or type of asset.
Furthermore, diversification can also help to reduce risk. The reason is that investors can protect themselves from risks specific to one asset/sector by owning several different assets.
In addition, diversification will even increase profit opportunities from various growth sources. This is because each asset or sector has different growth potential.
Benefits of Diversification in Investment?
After knowing what diversification is, now is the time to discover the benefits of diversification in investment. Knowing the benefits of diversification in investment is very important because it positively impacts the portfolio.
Below are several benefits of diversification that you need to know, including:
1. Reducing the Risk of Loss
With diversification, it means that there are many investment instruments in the investment portfolio. That means the risk of loss will be even smaller or reduced.
2. Helps Find the Right Investment Strategy
It is diversifying means that investors will be assisted in finding investment strategies that are right for them. However, it is still necessary to consider each investment instrument’s risk profile and risk level, as well as the investment objectives and timeframe.
3. Enlarge Profits in Investing
By diversifying and choosing the right investment instruments, investors can increase the profits they get from the various investment instruments they choose to invest in.
4. Minimizing Dependence on One Type of Instrument
With various investment instruments, investors have tried to minimize dependence on just one type of investment instrument. The reason is diversification will offer different levels of profit and risk.
How Diversification Works
The diversification mechanism in reducing risk allocates investment funds to different types of assets/financial instruments. The main mechanism of diversification is the spread of risk.
In this case, when an investor allocates his investment funds to various types of assets, he will reduce the risks associated with certain individual/sector assets. In addition, the diversification mechanism also considers the correlation between assets.
The correlation refers to the statistical relationship between price/value movements between two assets. By owning assets with a low correlation, investors can later reduce systematic risk in their portfolios.
Diversification can protect against market fluctuations. By diversifying, investors can avoid excessive exposure to certain sectors vulnerable to market fluctuations.
In addition, diversification can also open opportunities to take advantage of growth opportunities that may occur in various assets or sectors. This ultimately helps achieve a portfolio that is safe from sharp market fluctuations.
In the case of crypto investment, for example, we can see how diversification can work with the following examples, namely:
Suppose Investor A decides to diversify by dividing its investment funds into three different crypto assets, namely Bitcoin (BTC), Ethereum (ETH), and Ripple (XRP), with a composition of 40%, 30%, and 30%.
From the example above, investor A diversified by allocating funds to three different crypto assets. By dividing his investment funds into three crypto assets, investor A has reduced the risk associated with individual assets.
Types of Diversification
After understanding how diversification works, now is the time to find out the types of diversification, both in general and in the crypto world. This is important because each type has a different purpose and benefits.
The following are the types of diversification that need to be known, including:
1. Types of Diversification in General
In this type of vertical diversification, the strategy is to make a product with different levels of functions and benefits that can replace/complement each other.
In this type, the strategy is to make a variety of products that are similar in terms of type. The product differences will only lie in the brand, target market, and size.
2. Types of Diversification in the Crypto World
- Crypto Diversification
Crypto diversification means allocating investment funds to different types of crypto. By having several types of crypto in their portfolio, investors can significantly reduce the risks associated with changes in the value of one crypto asset.
Stablecoins are a type of crypto with a value that refers to stable assets, such as fiat currency (US dollars) or commodities. Including stablecoins in the portfolio can reduce the risk of high crypto market volatility.
- Utility Tokens
A utility token is a type of crypto that gives its holder access/rights to use services/products within a particular blockchain ecosystem. Diversification into utility tokens can provide exposure to different blockchain projects/platforms.
- Security Tokens
Security tokens represent ownership/rights to traditional assets, e.g., stocks, bonds, or real assets. This diversification into security tokens can provide diversification between crypto and traditional assets.
- ICOs and IEOs
Initial Coin Offering (ICO) and Initial Exchange Offering (IEO) are fundraising mechanisms for new crypto projects by developers and selling their tokens to investors.
As for diversification participating in ICO or IEO, various crypto projects can provide access to innovative projects with high growth potential.
Diversification Strategy in Investment Portfolio
Building a balanced crypto portfolio involves implementing the right diversification strategy. Several diversification strategies that can be considered include proportional allocation.
This strategy involves a proportional allocation of funds to the various selected cryptos. For example, if you choose four cryptos for your portfolio, investors can allocate 25% of the total funds for each crypto.
In addition, it can also diversify based on market capitalization. In this case, investors can allocate part of their funds to crypto with a large market capitalization and a small part to a smaller market capitalization.
Furthermore, properly allocating funds is essential to diversify the investment portfolio effectively. The reason is this will help manage risk in the portfolio.
Dividing funds across different types of assets or financial instruments reduces the risks associated with individual assets or certain sectors.
By allocating funds intelligently, investors can balance risk and potential benefits that suit their goals and risk tolerance.
It is important to note that monitoring and adjusting a diversified portfolio is important in maintaining portfolio balance and optimal performance.
In this regard, steps that can be taken include regularly monitoring portfolio performance. You can use a portfolio management platform or application, price charts, or market indicators in this case.
In addition, you can also evaluate investment objectives. In this case, ensure the portfolio is consistent with long and short-term goals.
Disadvantages and Advantages of Diversification
After understanding the diversification strategy in the investment portfolio, it’s time to know the advantages and disadvantages of diversification. It is important to understand the concept of diversification as a whole.
So, what are the advantages and disadvantages of diversification? The following is an explanation of each, namely:
1. Advantages of Diversification
- Reducing Specific Risks
Dividing investment funds into various types of assets means avoiding dependence on the performance of only one asset. If one of the assets decreases in value, then diversification can help to protect the portfolio from a significant negative impact.
- Increase Profit Opportunities
Owning several different assets means the opportunity to benefit from various sectors or financial instruments that are performing well.
- Protect Portfolio
Diversification also helps to protect the portfolio from risks associated with individual assets or certain sectors. By having a diversified portfolio, potential losses from one asset/sector can be offset by the positive performance of other assets.
2. Lack of Diversification
- Potential Losses to Top Performance
One drawback is that by dividing investment funds into various assets/instruments, investors may not benefit from the assets with the highest performance.
- Difficulty Following Specific Trends
Diversification can also make it difficult for investors to follow specific trends or emerging investment opportunities within a particular asset or sector.
If there is a significant trend/opportunity in one asset, but the allocation of funds is spread across various assets, investors may need help to take full advantage of that opportunity.
- Higher Transaction Fees
Diversification that is too broad/excessive can increase transaction costs. Every time an investor buys/sells an asset, he has to pay a transaction fee, such as a trading or brokerage fee.
Let’s Diversify Your Crypto Assets
It should also be noted that in recent years, investment in crypto assets has been very popular in the world, including in Indonesia. However, like any other investment, investing in crypto involves risks that need to be taken seriously.
Well, one way to manage this risk is through diversification. As mentioned earlier, this diversification in crypto assets refers to allocating investment funds to various types of crypto.
Ultimately, with a good understanding of the importance of diversification in these crypto assets, investors can build a more balanced portfolio and manage risk better.
In conclusion, diversification is important in crypto investing because it can help reduce the risks associated with investing in crypto. With diversification, crypto investors can take advantage of growth opportunities from various projects and types of digital assets.
Meanwhile, the main mechanism of diversification is the spread of risk. In this case, when an investor allocates his investment funds to various types of assets, he will reduce the risks associated with certain individual/sector assets.
On the other hand, there are two types of diversification: diversification in general and diversification in the crypto world. The types generally consist of (1) vertical and (2) horizontal.
The types of diversification in the crypto world consist of (1) crypto diversification, (2) stablecoins, (3) utility tokens, (4) security tokens, and (5) ICO and IEO.
Diversification also plays a crucial role in building and managing a healthy investment portfolio. Diversification can reduce specific risks associated with certain individual assets/sectors.
In addition, diversification also allows investors to take advantage of potential profits from various types of financial assets/instruments.
Keep in mind again diversification also has some advantages and disadvantages that need to be considered. Among the advantages of diversification are (1) reducing specific risks, (2) increasing profit opportunities, and (3) protecting the portfolio.
On the other hand, the disadvantages of diversification include (1) potential downside to top performers, (2) difficulty following specific trends, and (3) higher transaction costs.
Furthermore, it would help if you planned for appropriate diversification in your crypto portfolio. Among the steps that can be implemented are determining investment objectives and recognizing risk tolerance.
In addition, it is also important to study various types of crypto and determine the allocation of investment funds that are balanced in the types of crypto assets that exist and evaluate these investments regularly.
Well, now you understand what diversification is, its benefits in investment, how it works, the types, the advantages and disadvantages.
Next, you can start investing in crypto on the most popular crypto trading platform, namely INDODAX.
Before investing in INDODAX, you can download this best crypto trading application.
You need to know one of the newest features of INDODAX is INDODAX Earn or crypto staking. With this feature, you can lock your crypto assets.
Like saving money on a deposit, the crypto assets locked in INDODAX Earn will generate rewards in the future, just like the interest you earn when you save.
The INDODAX Earn/staking crypto feature can be accessed anytime and anywhere via the Mobile App. Besides that, you can also use the desktop on the INDODAX website, namely on the INDODAX Earn/staking crypto page.
Come on, invest in crypto right now!