Last year, it felt as if crypto prices would only go in one direction and investors could do no wrong. Even a trading hamster was able to pick winning cryptos. But today, many cryptos are down 80% or more from their all-time highs. This is a stark reminder that these are risky investments that can go down as well as up.
Many of the golden rules of crypto investing center around the idea of minimizing risks. If you’re going to buy crypto, the ideal scenario is that you benefit if crypto prices soar, but don’t face financial disaster if the market collapses. These five rules will help you do just that.
1. Only invest money you can afford to lose
When you see predictions that Bitcoin (BTC) could go to $1 million, the temptation is to put every available cent into the king of crypto in the hopes of big gains. The trouble? You could lose all that money. If you only invest money you are comfortable losing, you won’t face financial ruin if the industry goes sideways.
Crypto investing is risky. There’s a chance the blockchain could revolutionize the way we manage money or even become the future currency of the internet. But it may not. Many projects will fail and the whole industry could collapse completely. Whether it’s regulation, the introduction of central bank digital currencies (also known as Gov Coins), or the evolution of even newer technology, it has a number of significant hurdles to overcome.
2. Cover other financial bases first
If you want to invest in crypto, it’s important to first build strong financial foundations. That means having an emergency fund to cover three to six months of living costs, as well as being on top of your retirement contributions. If you’re trying to pay down debt, prioritize this over any crypto investments.
If you face a financial emergency next week, an emergency fund will help you cover it without taking on debt, or having to sell assets, potentially at a loss. Imagine you’d spent $2,000 on Bitcoin last November instead of putting it into an emergency fund. It could be worth as little as $600 today. While it may recover in the long term, that wouldn’t help if you’d been forced to sell today. How would you feel if you lost your job this week or faced a medical crisis and your financial cushion was in Bitcoin rather than a bank?
3. Diversify your investments
Diversification comes in various forms — the types of assets you buy, and the individual assets within each class. Most experts recommend only putting a small amount of your total portfolio into crypto. The rest should be in lower-risk assets such as real estate or equity. Exactly how much depends on your tolerance for risk, belief in crypto, and financial situation. If you have decades ahead of you before you plan to retire, you might be more willing to take on more exposure to cryptocurrencies as you’d have more time to recover if things went wrong.
It’s also good to diversify within your crypto portfolio. Some people choose to only invest in Bitcoin and Ethereum (ETH), which makes sense as these are the most established cryptos and have the best chance of surviving long term. But if you want to buy smaller altcoins, don’t go all in on one or two.
Consider a mix of crypto sectors depending on which ones you think are promising. For example, my portfolio is heavily weighted toward smart contract cryptos, because it is an area I’ve researched a lot and I like that many other cryptos are built on these blockchains. I have some exposure to gaming and metaverse tokens, and I steer clear of privacy tokens completely. Other investors will likely have different priorities and areas of knowledge.
4. Think long term
One way to survive the volatility of crypto is to invest with a 10- to 20-year mindset. Attempting to time the market through short-term trading is almost impossible to do — and many investors lose money this way. Instead, look for projects with strong leadership and good utility that may perform well in the coming decades.
It isn’t always easy to think long term because this is such early days for the industry and there’s a lot we don’t know about how it will evolve. But it’s an approach that will help keep even prolonged dips in perspective and prevent making emotional decisions. As an example, if you’d bought each of the top 50 cryptos five years ago, you’d be looking at an increase of about 700% — in spite of the fact that many projects did not survive the 2018 crypto winter.
Never buy a cryptocurrency you haven’t researched in depth. We all live busy lives, and it can be tempting to put a small amount of money into an altcoin you read about online. But it’s your money and there’s a lot of misinformation out there. Only you know your investment strategies and goals. Research doesn’t guarantee success, but it significantly reduces the chance of being scammed or buying a crypto that doesn’t have good long-term potential.
Crypto is a relatively new asset class. Last year, some people felt pressured to buy crypto so they could get in early on the next big thing. They bought crypto out of a fear of missing out — in some cases with money they needed in the short term, at the cost of other financial goals. If you’re considering buying crypto, it’s crucial you shore up your finances and research the industry first. That way a further crypto crash will be disappointing but not devastating.
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We’re firm believers in the Golden Rule, which is why editorial opinions are ours alone and have not been previously reviewed, approved, or endorsed by included advertisers.
The Ascent does not cover all offers on the market. Editorial content from The Ascent is separate from The Motley Fool editorial content and is created by a different analyst team.Emma Newbery has positions in Bitcoin and Ethereum. The Motley Fool has positions in and recommends Bitcoin and Ethereum. The Motley Fool has a disclosure policy.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.