One of the key skills to master as a crypto participant is careful portfolio management. Below we outline the key steps — from asset allocation to rebalancing and other important concepts like diversification and active versus passive management. This knowledge can help with selecting the best approach for one’s personal portfolio style.
Table of Contents
- Portfolio management is the process of selecting and managing a group of investments to meet specific financial objectives and risk tolerance.
- The key steps in portfolio management typically are asset allocation, investment selection, trade execution, monitoring, and rebalancing.
- Other important concepts to know in portfolio management are diversification and active versus passive management.
What Is Portfolio Management?
Portfolio management is the process of selecting and managing a group of investments to meet specific financial objectives and risk tolerance. In crypto, this means selecting different tokens and coins. The expected return of the portfolio is a typical financial objective, and risk tolerance is the level of volatility that’s acceptable. Selecting the right mix of crypto assets for a portfolio, therefore, is important in order to achieve the desired return and risk tolerance.
The key steps in portfolio management typically are asset allocation, investment selection, trade execution, monitoring, and rebalancing. Other important concepts include diversification and active versus passive management.
Asset Allocation and Investment Selection
If a portfolio consists of crypto and other asset classes (such as stocks and bonds), asset allocation determines how much of the portfolio is invested in each of the asset classes. The amount is also often referred to as the portfolio weight. On the other hand, if the portfolio is strictly crypto, then an investor considers the allocation to the different crypto categories — Layer-1, decentralised finance (DeFi), meme coins, and gaming-related tokens, for example.
Once the broad categories are chosen, the investor then selects the individual tokens (i.e., investment selection) within those categories for their portfolio. This method of filtering is sometimes known as ‘top-down’. Alternatively, the investor could start by choosing the individual tokens first, which is known as the ‘bottom-up’ method.
This refers to buying and selling crypto tokens once they have been selected to be in (or out) of the portfolio. Transaction costs should be considered, as they can reduce the portfolio return. Another important concept is slippage, which is the actual price that the trade is executed at compared to the price the investor was targeting. For example, if the actual executed price of a buy order turns out to be higher than the target price, it could have negative implications for the potential return.
This involves regularly monitoring the performance of the overall portfolio and the individual tokens within it since markets and developments around crypto tokens can change rapidly and affect the characteristics of the portfolio. For example, the investor’s view on tokens inside or outside the portfolio could change due to new developments, leading to deciding whether or not to continue investing in a particular token (or perhaps replace it with another).
Additionally, the portfolio’s overall return may not perform to expectations, so the investor may have to revisit their asset allocation and investment selection process to see what changes can be made to potentially help the situation.
Rebalancing is used to restore the target weights of categories and individual tokens in the portfolio. This is because movements in crypto prices naturally change the weightings inside the portfolio.
For example, gaming-related tokens could experience a surge in prices due to positive developments in the category, increasing the weighting of this category in the portfolio beyond the target range. Selling gaming-related tokens would be a rebalancing action to lower the weighting of this category back to the target range.
Rebalancing aligns with the idea of buying low and selling high since it involves buying those categories and tokens that have fallen in price (hence, are below target weight) while selling those that have risen in price (hence, are above target weight).
Rebalancing can be done at regular intervals — monthly, quarterly, or annually — to ensure the portfolio’s target investment mix is adhered to. A key consideration for how often to rebalance is transaction costs, as more frequent rebalancing typically incurs more costs.
Since it is very difficult to consistently pick winners and losers, a prudent approach is to invest the portfolio in many different tokens. This is called diversification, or ‘not putting all the eggs in one basket’. Taking an extreme example, if the portfolio is invested in only one token, and the token loses all or most of its value, the entire portfolio is then wiped out.
A portfolio invested in only a few tokens is considered a concentrated one. While this is potentially risky, the advantage it has over a diversified portfolio is that, if the selected few tokens turn out to be the correct bets, then the portfolio return could potentially be greater. Typically, a concentrated portfolio in just a few tokens could be considered if the investor has a very high conviction in those tokens.
Active vs Passive Management
Active portfolio management is when the investor ‘actively’ participates in choosing which investments to include in the portfolio. For example, they conduct research and analysis on the market, categories, and individual tokens, trying to forecast price directions in the hope of selecting investments that will generate the best return.
On the other hand, passive portfolio management is when the investor does not actively select which investments to include. Instead, a benchmark or index is typically chosen, which is already comprised of a large diversified selection of tokens (chosen by the index provider). A passive portfolio simply invests in the same tokens as the index and also at the same weights that each token has in the index. The aim is for the portfolio performance to passively track that of the index, neither outperforming nor underperforming it. While there are many well-established benchmarks and indices in stocks — such as the S&P 500 Index in the US, Hang Seng Index in Hong Kong, and FTSE Indices in the UK — this is still an emerging space in crypto.
Compared to passive portfolio management, active management requires the investor to put more resources, effort, and time into conducting research and analysis to select the best investments; although, the potential return of an active portfolio could be greater if the investment picks turn out to be successful.
Final Words on How to Manage a Crypto Portfolio
Portfolio management is the process of selecting and managing a group of investments (in crypto, this would be different coins and/or tokens) to meet specific financial objectives and risk tolerance. Important concepts include diversification and active versus passive management — these are based on traders’ personal preferences, and no single ‘right’ or ‘best’ portfolio management style exists.
Another important component of crypto portfolio management is DYOR — do your own research — on projects and tokens before investing. Learn what factors to consider before buying. Understanding portfolio management can help in selecting the right mix of crypto tokens for a portfolio in order to achieve the desired return and risk.
Due Diligence and Do Your Own Research
All examples listed in this article are for informational purposes only. You should not construe any such information or other material as legal, tax, investment, financial, or other advice. Nothing contained herein shall constitute a solicitation, recommendation, endorsement, or offer by Crypto.com to invest, buy, or sell any coins, tokens, or other crypto assets. Returns on the buying and selling of crypto assets may be subject to tax, including capital gains tax, in your jurisdiction.
Past performance is not a guarantee or predictor of future performance. The value of crypto assets can increase or decrease, and you could lose all or a substantial amount of your purchase price. When assessing a crypto asset, it’s essential for you to do your research and due diligence to make the best possible judgement, as any purchases shall be your sole responsibility.