Crypto and diversification: Why spreading risk matters

Cryptoassets may not be regulated financial products, so please be aware that trading them carries a considerable amount of risk for your capital. Cryptocurrencies are also not covered by existing consumer protection laws and are not suitable for the majority of investors.

Compared with traditional investments, crypto tends to experience greater volatility. That doesn’t mean you can’t invest in crypto, but it’s an important reminder of why diversification and a long-term investment strategy are important. 

Diversification could help you manage investment risk

First, all investments carry some risk and returns cannot be guaranteed. There is always a risk that investment values will fall. However, the amount of risk associated with an investment may vary significantly, and there are ways to manage the level of risk you take.

Diversification is one such strategy.

Rather than putting all your money into a single area, you spread it across different asset classes, sectors and geographical regions. In simple terms, it means you’re not putting all your eggs in one basket.

The theory behind diversification is that if one part of your investment portfolio falls in value, it can be offset by stability or gains in another. As a result, it aims to reduce the amount of volatility your portfolio experiences and reduce the risk of losing your entire investment. 

The Financial Conduct Authority explains what diversification looks like in practice using an example involving £1,000 and three options.

1. Option one doesn’t diversify the investment. You use all the money to buy shares in a single company. It could go well or it could go badly; either way, your investment’s performance depends entirely on the share price.
2. Option two involves some diversification, with your investment spread across different UK companies. Your investment performance is no longer tied to the performance of one company, as it’s invested in businesses operating across multiple business areas in the UK, which may help reduce the impact if one sector struggles.
3. Option three is full diversification. You invest beyond the UK, spreading your money across different markets. This would spread risk further, as your portfolio would be exposed to different types of investment and different economies.

Investing solely in crypto would be like choosing no diversification – the value of your investment would depend on the crypto market. 

Diversification could reduce knee-jerk investment decisions during crypto volatility 

As mentioned above, crypto often experiences sharp peaks and dips. Considering crypto’s volatility alongside your other investments could be useful.

As well as potentially reducing overall investment risk, looking at the wider context could prevent you from reacting to short-term market movements. Sharp falls in investment values may tempt you to withdraw your money to prevent further losses. While this might seem sensible, you could miss out if the market subsequently recovers.

If you’ve invested in line with your long-term strategy, it may make sense to ride out volatility. This applies to crypto too.

So, if you’re tempted to respond to headlines declaring that crypto is falling, or a dip in value makes you feel nervous, review your overall portfolio and assess performance over years, rather than weeks or months. This could help you gain a more accurate picture of whether your investment strategy is supporting your goals, rather than judging it by a snapshot taken during a period of uncertainty. 

Making crypto part of your financial plan could support your goals

While you might think of crypto as being separate from your traditional assets, making it part of your wider financial plan could help you manage the risk and understand how it could support your goals.

For example, if you decide to invest a portion of your wealth in crypto, you may take a more cautious approach to your other investments.

Alternatively, you may create separate investment pots based on how important each goal is to you. If you’re saving for your child’s education, you may want to invest in lower-risk opportunities because you don’t want to risk losing the money. On the other hand, you may feel comfortable taking more investment risk with money that isn’t tied to a life milestone, so you might choose to invest that money in crypto.

Making crypto part of your financial plan could help you assess your decisions in the context of your wider goals.

Get in touch

If you’d like to talk about how to create a tailored investment portfolio that reflects your goals and circumstances, including crypto in your financial plan could help you assess investment decisions in the context of your wider goals. 

Please note: This article is for general information only and does not constitute advice. The information is aimed at individuals only.

All information is correct at the time of writing and is subject to change in the future.

The value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. 

Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.