Markets can go through periods of ‘irrational exuberance’ about new technologies and in the beginning stages, prices can be quite volatile until they level out over the long term.
However, since there’s so much interest in how to invest in Bitcoin, we share our tips on how to invest in Bitcoin in a way that allows you to manage your risk and set yourself up for long-term success.
If you want to find out more about Bitcoin and cryptocurrency generally, then first read our piece answering what is Bitcoin and cryptocurrency.
The best way to invest in Bitcoin or other cryptocurrencies:
1. Consider your financial position
First, stay clear if you’re not in the financial position to be speculating in the first place because you have debts or expenses coming up. Do not borrow money to speculate. Repeat: do not borrow money to speculate.
2. Limit your exposure
It’s wise to limit your exposure to risky investments like Bitcoin to a small percentage of your wealth. That way, if it doesn’t work out you won’t be devastated financially. If it does work out, then you’ll be better off, but without risking all your hard-earned cash. Additionally, if you bet a small amount of your total savings, you can ride out the falls and won’t feel forced to sell when the inevitable falls do happen.
3. Dollar cost average
With risky investments, it’s worth dollar cost averaging rather than buying your entire amount at once. Buying small amounts over time is obviously more difficult with some assets (like art) but can be done with individual shares or Bitcoin.
By dollar cost averaging you can reduce the chance of being like the investors who bought Amazon in 1999 for $110, and waiting 10 years to get back to breakeven.
Dollar cost averaging improves your chances of doing well in the long run if you’re eventually right, because it reduces the impact of market timing. Trying to time the market is dangerous because the most tempting time to buy is usually the time you shouldn’t be. Bitcoin in 2017 was a great example of market timing. A lot of people invested too much of their savings near the highs of $20,000. A better strategy would have been drip feeding small amounts, which would have offset the effect of the Bitcoin price falling to approximately $4,000.
4. Know your counterparty risks
Many people invest in Bitcoin through Bitcoin exchanges. But when you invest this way, you don’t hold the underlying asset, and you’re relying on someone to hold and manage it on your behalf. This adds an extra level of risk, called counterparty risk. Some Bitcoin exchanges have gone bust, and many Bitcoins have been stolen. Unfortunately, little protection exists in this area for consumers.
Unfortunately, fast rising markets like Bitcoin and other cryptocurrencies attract fraudsters and financial cowboys. That’s why it’s so important to understand your ‘counterparty risk’ and what protections you have (if any). You may want to consider owning your cryptocurrency on a hard wallet but this comes with it’s own set of complexity and risk.
5. Remember to rebalance
Rebalancing allows you to lock in some of your profits to reduce your risk. If you’re lucky enough to make outsized gains in any speculative investment, don’t forget to rebalance.
Essentially, rebalancing involves selling some assets that have done well and buying some that haven’t. Find out why we rebalanced in March 2020.
With Bitcoin, let’s say you bought at the start of 2017 when Bitcoin was trading at $1,000 and allocated 2% of your wealth.
By the end of 2017 when Bitcoin traded at nearly $20,000, the amount invested in Bitcoin might have been approximately 26% of your savings – a much bigger part of your portfolio. To ensure proper diversification, you’d want to take some of that money out, and put it back into another underperforming asset.
Investors who followed this strategy avoided the large 80% drop in the Bitcoin price that occurred during 2018. Those that didn’t rebalance lost a lot of money because they didn’t harvest some profit, which is essential for minimising regret.
6. Ignore short term market movements
Watching Bitcoin prices go up and down on a daily basis will almost certainly cause you to buy and sell too often and destroy any long term gains. If you’ve followed the above rules, be confident in your process and ignore the daily noise because it’s irrelevant if Bitcoin is successful in the long term.
If you want to invest into Bitcoin or any other cryptocurrencies, stick to a process. Have a small position size relative to your overall portfolio, dollar cost average, rebalance to reduce your risk over time, and ignore the noise along the way. Following these steps will give you the best chance of long term success, while keeping your savings safe in the meantime.
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