Don’t Be Your Own Worst Enemy When Investing

Looking for someone to blame for the not-so-stellar performance of your investment portfolio? Try checking the mirror.

 

Decisions about money aren’t always rational, even when we think we’re acting logically. Common tendencies that make us our own worst enemies when investing include: selling winning investments too soon or holding onto losers for too long, loading up on too-similar assets or failing to assess the future implications of today’s decisions.

Researchers have found dozens of unconscious biases that can drive people to make money decisions they later regret. These behavioral economics concepts include things like “anchoring” — when a specific and perhaps arbitrary number you have in mind sways your decision-making, such as selling Apple just because the company’s stock hit a round number, like $200 a share. Or, the “endowment effect” can cause you to overvalue something simply because you own it, leading you to cling to a stock that’s tanking.

Here are some common human errors in investing, with strategies to overcome them.

Pursuing past predilections

Financial institutions remind us that past performance doesn’t guarantee future results. We don’t always listen.

It’s tempting to look at a stock’s (or the broader market’s) recent performance and conclude gains will persist in the near term, says Victor Ricciardi, a finance professor at Goucher College and co-editor of the books “Investor Behavior” and “Financial Behavior.” “People take a very small sample of data and draw a major conclusion, and that’s a pretty bad pitfall,” Ricciardi says.

How to overcome it: Don’t base investing decisions solely on what’s happened in the past; think about what will drive gains in the future. When investing for the long term, prioritize selecting companies with solid long-term potential.

Diversification that’s not diverse

You may interpret diversification to mean more is better. That’s only half the story; what’s important is owning a variety of assets (both stocks and bonds) with exposure to various industries, companies and geographies.

Sometimes investors exhibit “naive diversification” by owning too-similar assets, which does little to reduce risk, says Dan Egan, director of behavioral finance and investments at robo-advisor Betterment: “People will have three or four different S&P 500 funds and think they’re diversified but don’t look at how correlated they all are.”

Similarly, many investors invest only in companies they know, which results in over-concentration in certain industries, Ricciardi says. That may mean underexposure to “the unknown” — like international stocks — which they perceive to be risky, he adds.

How to overcome it: Invest in a wide range of assets. This can easily be accomplished with a simple portfolio constructed of just a few mutual funds or exchange-traded funds.

Making emotional decisions

When money’s on the line, it’s hard not to let emotions creep into your decisions.

Prior to the 2016 presidential election, many professional investors expressed concerns about a market slump if Donald Trump won. Betterment data suggested that investors who supported Hillary Clinton might let politics shape their investment strategy — and cash out following the election, Egan says. So after the election, the robo-advisor messaged investors with information about the importance of staying invested for the long haul, he says.

On a stock-specific basis, we often let emotions dictate when to sell — not wanting to admit we made a losing bet. “People tend to sell winners too quickly when they go up and, on the downside, they hold on to losing investments too long,” Ricciardi says.

How to overcome it: Think about individual investments in the context of your entire portfolio and craft a plan for when you’ll sell that’s not triggered by short-term factors (like emotions) alone.

Focusing on today

It can be difficult to see the value of saving money for tomorrow when there’s so much to spend it on today. That myopia can make investors either too active or too passive.

If you’re too passive, you may avoid regular check-ins on financial health and stick with a status quo that doesn’t properly prepare for the future, Ricciardi says. Meanwhile, being too active can drive up trading expenses, resulting in lower returns, he adds.

How to overcome it: Let the numbers do the talking. Sit down with a retirement calculator when charting your investing journey. Make sure you fully understand the tax implications and costs associated with selling investments.


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Author: Anna-Louise Jackson
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Poll: Cryptocurrency Will Make Up 5% of U.S. Investing in 2019

Investment Outlook Grows While Education Remains Limited

Cryptocurrency–A new survey conducted by The Harris Poll has found that cryptocurrency represents a decent portion of the expected investment by Americans for 2019. Despite the continued decline in Bitcoin price and overall valuation for the crypto markets, outlook for future investment still remains strong as more Americans are planning to get involved in the coming year.

LIONBIT

American Investors Looking to Cryptocurrency in 2019

Traditional stocks, bonds and real estate still hold the lion’s share of market interest, but perception is growing among U.S. investors that cryptocurrency might be the next big asset class to take part in, particularly to a degree that mitigates overall portfolio risk while still gaining exposure to the upside. Commissioned on behalf of the American Institute of CPAs (AICPA), The Harris Poll survey found that among the 35 percent of Americans who classify themselves as current investors or plan to invest in 2019, cryptocurrency will make up 5 percent of their overall investment. To put that number into perspective Exchange Traded-Funds (ETFs), which have dominated cryptocurrency headlines following the back and forth process through the U.S. Securities & Exchange Commission, constitute 8 percent of projected investment funds. With the SEC delaying decision on VanEck’s bid to form a Bitcoin ETF to the end of September, it’s possible there will be a crossover of the two investment classes by the time 2019 rolls around.

In addition to judging investment interest into cryptocurrency, the survey sought to gauge education and understanding of the industry within America’s active investors. While the numbers were in line with other reports of lower-than-desired education levels, the poll reports just under 50 percent of respondents had little to no understanding of cryptocurrency–a sign of the times that the industry still has a long way to go before reaching market saturation and greater adoption. In a statement addressing The Harris Poll findings, the AICPA remarked upon the level of familiarity exhibited by American adults towards cryptocurrency, despite the promising numbers for future investment,

TIP

“Cryptocurrency appears to be foreign to many investors. The survey found that nearly half of U.S. adults (48 percent) are not familiar with Bitcoin, Ethereum, or Litecoin.”

The poll also found that current investors into cryptocurrency and those who were familiar with the industry held disagreeing opinions over the future of the market, an understandable sentiment given the volatility experienced throughout 2018. Among respondents who fit this criteria, 24 percent expected cryptocurrency to continue to appreciate in price, despite the current bear trend, while 29 percent reported that the market was in for further decline. Respondents also identified market volatility, with 35 percent believing that the price would continue to fluctuate wildly, and only 12 percent reporting that prices would stay the same.

Reflecting the balanced portfolio approach of polled investors, which weighed cryptocurrency as only a small, but risky portion of their overall investment, the AICPA report cautioned over the risks associated with crypto while taking a long-term approach on the market,

“Before Americans invest their hard-earned money, it is important they take control of their financial future and do some research … A well-researched and properly diversified portfolio that matches an investors risk tolerance will give confidence to stay focused on long-term strategy and protect from the temptation to sell during short-term price swings.”


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Just Diversify? With Crypto Portfolios, It’s Not So Simple

With over 1,560 cryptocurrencies for investors to choose from, the abundance can seem overwhelming.

But it also raises an interesting question: How important is it to have exposure to a range of cryptocurrencies? Is it worth diversifying your holdings in order to mitigate risk? The work of Harry Markowitz might lead you to think so.

The Nobel Prize-winning economist, author of the classic 1952 article “Portfolio Selection,” devised modern portfolio theory (MPT), which stresses that diversifying assets is crucial. I you diversify enough, you will make risk go away and get the mean. Time and time again, Markowitz’s research has shown that investors can assemble the perfect portfolio.

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Indeed, recently published research by the Bocconi Students Investment Club at Bocconi University in Milan, Italy, showed that applying the MPT framework to crypto beat all other portfolios, at the cost of a greater volatility.

The investment club wrote:

“Our findings, consistently with MPT, are that portfolio variance can be significantly lowered by exploiting low covariances between coins.”

In this way, it’s a validation of the idea that 50 to 60 percent of a crypto portfolio should be core holdings of the two largest coins by market capitalization, bitcoin and ether. Alternatives, the thinking goes, should be added only after.

Jeffrey Van de Leemput, a co-founder of Cryptocampus, a crypto mentoring group, says diversifying your portfolio is very important. Not only will this mitigate risk but it can also substantially increase the reward factor of a portfolio.

“Personally, I like having 80 percent large caps and 20% small caps mixed in for performance,” says Leemput.

All go down together

But this risk mitigation strategy may be hard to pull off in crypto. When we saw the price of bitcoin plummet earlier this year, it dragged all the other cryptos’ prices down too.

Hence, some disagree with Markowitz’s theory, or at least its applicability to the brave new world of cryptocurrency.

Dejun Qian, founder of the FUSION Foundation, a public blockchain project, says diversification could help to increase the possibility of finding a good bet. He warns that in this market, 90 percent of the projects will die in the future. Diversifying will help us to capture that 10 percent.

The fun part is hunting for those golden nuggets — the initial coin offering (ICO) tokens and small caps that you believe will have the potential to succeed in the long run. But in most cases, diversification doesn’t help with limiting risks because cryptocurrencies have repeatedly entered periods where they move in tandem, Qian said.

And it bears repeating that in this market the risk is high and crypto investing is not suitable for every investor. Do your own research.

That includes at least entertaining the arguments of so-called maximalists, who claim that there can only be one winner in cryptocurrencies (whichever one they’ve invested in, naturally), because money relies on network effect.

Maximalists can be rude and clannish, especially on Twitter, but that doesn’t mean they’re wrong. And if they’re right, diversification is just “spraying and praying.”

Going mainstream

Then again, stocks and bonds aren’t riskless either, and even some Wall Street analysts say crypto itself could serve as a diversification play for mainstream investors.

JP Morgan strategist John Normand examined the potential role of cryptocurrencies in diversifying a global portfolio in a 71-page research report on cryptocurrencies published in February.

He wrote:

“Given both their high returns over the past several years and their low correlation with the major asset classes, offsetting some of the cost of high volatility. If past returns, volatilities and correlations persist, CCs could potentially have a role in diversifying one’s global bond and equity portfolio.”

Qian observes that we have seen the market cap of cryptocurrencies soar from no more than $1 billion to $700 billion early this year (though it was down to $329 billion at the beginning of June). No one can deny this market is becoming more and more important. But it remains very small compared to the fiat currency market.

“Along with this exponential growth, having some cryptocurrencies in someone’s investment portfolio not only can help him catch the return from this booming but also can help him to understand more about this new world,” says Qian.

Summing up, Markowitz’s MPT is for risk-averse investors.

It is a well-known investment strategy which guides investors to combine a portfolio of assets with returns that are not always positively correlated in order to lower portfolio risk without sacrificing return. But be warned that crypto is not yet a mature asset class and hugely volatile therefore correlation and patterns are difficult to predict.



Here at Dollar Destruction, we endeavor to bring to you the latest, most important news from around the globe. We scan the web looking for the most valuable content and dish it right up for you! The content of this article was provided by the source referenced. Dollar Destruction does not endorse and is not responsible for or liable for any content, accuracy, quality, advertising, products or other materials on this page. As always, we encourage you to perform your own research!
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How To Diversify Away Risk In A Crypto Portfolio: Correlation And Variance

Observations of the crypto market give impression that “when Bitcoin sneezes, the cryptocurrency market catches a cold”, – in traditional stock markets this would not be the case. Although there are public companies whose stock movements have strong correlations due to those doing similar work in the same industry – oil companies, for example – investors are still capable of diversifying away risk in an equally weighted portfolio by adding stocks with negative correlations to the portfolio.

Technically, diversifying away risk in a crypto-only portfolio could be difficult. Creating a two-asset portfolio with highly correlated stocks gives an investor a greater risk of losing more wealth. When two assets have a strong correlation coefficient they tend to move in the same direction. If  two assets in the same portfolio move in the same direction then your gains in wealth will be greater and your losses more severe. That could be the reason why investors try to create portfolios with negatively correlated stocks.

If one asset is declining in a portfolio consisting of two assets that are negatively correlated, then the other asset in the portfolio should be increasing. This should in effect diminish the maximum amount of wealth that can be lost in a portfolio.

Just from checking out the digital asset prices on a cryptocurrency exchange, one can see that they are highly correlated with one another.  If Bitcoin is in the red for the day, nearly every cryptocurrency on the homepage will be in the red, if Bitcoin is in the green, – so would be the others. That is why people say that “even the most unseaworthy boats will float when the tide rises”.

Correlation of Cryptocurrencies

Economic researcher Vasily Sumanov told Cointelegraph the cryptocurrency market is highly correlated because most altcoins are bonded to Bitcoin:

“The market is very small [market cap] and has low-liquidity, a majority of the trade volume is provided by algorithmic traders using bots. There are only a few exchanges who actually establish prices but prices at these exchanges are connected to arbitrage bots also. All digital assets are really bonded to the BTC market – besides stable coins like USDT – so every change in the market is immediately mimicked by other assets.

When BTC/USD is falling, all digital assets/USD are falling because the price of a majority of digital assets is being calculated via the USD/BTC price.  For example, when BTC is falling, traders could sell altcoins for BTC. Afterward they could immediately sell Bitcoin, and receive dollars and then buy back their BTC at a lower price. Then they could buy cheap altcoins with their Bitcoin.”

It could be well illustrated by this winter fall of the crypto market. Here is what it looked like, for example, on Feb. 2, 2018. While Bitcoin lost 15%, Ripple lost 30% –  XRP could have become cheaper due to the algorithm used by a majority of traders.

Chart

 

In a correlation matrix created from the yearly returns of Bitcoin (BTC), Ethereum (ETH), Litecoin (LTC), and Ripple (XRP), there are seven out of ten digital asset pairs that are perfectly correlated; BTC-BTC, BTC-ETH, ETH-ETH, ETH-LTC, ETH-XRP, LTC-LTC, and XRP-XRP. The three other pairs still show strong correlation – anywhere between .7 and 1: BTC-LTC is correlated at  .934, BTC-XRP at .729, and LTC-XRP at .892.

BTC, ETH, LTC, XRP - MATRICES

Trading systems technology and operations consultant Tony Karim shared with Cointelegraph his opinion that digital assets are highly correlated due to investor sentiments and systematic risks:

“Mainstream crypto assets (not so much with newer altcoins) are closely correlated in their volatility due to the same catchment of underlying investors who are almost exclusively sentiment driven with similar trading motives without reviewing any of the drivers and flow of this market.”

“The recent devaluation has been due to fundamental activities and pressure be it regulators, thefts from exchanges and individuals, and other negative publicity. Therefore, when one crypto asset is impacted, this propagates to completely different cryptos using totally different technology on a bear or bull trend on the mainstream assets by market volume. Another fact is liquidity is in the hands of a few and based on the total number of crypto assets actively trading daily vs the number in circulation. There isn’t the same sense of liquidity that is present in other markets.”

If crypto-assets fall victim to high correlation coefficients, would it be possible to diversify away risk in an equally weighted cryptocurrency portfolio by adding more crypto-assets?  To answer this question we will analyse the expected returns and standard deviations (SD) from a series of portfolios constructed from Bitcoin, Ether, Litecoin, and Ripple.  All the data analyzed consists of yearly prices taken on Oct. 5, as the first day for the earliest year available.

Single Asset Portfolios

PRICES, VARIANCE AND STANDARD DEVIATION OF BTC, ETH, LTC, XRP

Bitcoin

Bitcoin’s blockchain was launched on Jan. 3, 2009. Based on the yearly returns from 2010 to 2017, with a portfolio that consists of only Bitcoin, you can expect a 194.2 percent return on average. The standard deviation – the amount you can expect the returns to deviate from the average – associated with holding a portfolio of only Bitcoin is 168.8 percent. This means that the returns you can expect from Bitcoin could deviate 168.8 percent above or below the average return.

Ethereum

Ethereum was released on July 30, 2015 as a blockchain network that allows companies to create applications, contracts, or systems via programming on the Ethereum network. The data for Bitcoin and Ethereum in this article was pulled from 99Bitcoins.

If you hold a portfolio that consists of only Ethereum, you can expect a 307.29 percent return based on Ether’s yearly return data from 2015 to 2017. The standard deviation of an Ethereum only portfolio is 6.06 percent. This means that one can expect the yearly returns of Ethereum to be rather reliable and not stray too far from the average return of 307.29 percent. That being said, Ethereum has only existed for 3 years.

Litecoin

Litecoin was released on Oct. 7, 2011, created from a fork in the Bitcoin Core blockchain. For that reason, Litecoin is very similar to Bitcoin, and that may be why Litecoin does not have its own white paper. Litecoin aims to solve some of the problems associated with Bitcoin such as network efficiency and transaction verification speed. The data for Litecoin in this article was pulled from Bitinfocharts.

Based on the yearly returns of Litecoin from 2013 to 2017, if you hold a Litecoin-only portfolio, you can expect a return of 136.1 percent with a standard deviation of about 163.6 percent.

Ripple

Ripple was released in 2012 as a cryptocurrency and global remittance service for banks to make nearly instantaneous cross border payments for an amount lower than traditional transaction fees. The data for Ripple in this article was pulled from Coinmarketcap.

Based on the yearly returns from 2014 to 2017, with a portfolio that only consists of Ripple, you can expect a 80.3 percent return on investment. A Ripple-only portfolio has a standard deviation of about 182.5 percent.

Two Asset Portfolio

In a two asset portfolio the expected returns will increase in respect to every single-asset portfolio except when comparing the Litecoin-only portfolio to the LTC-XRP portfolio, the Bitcoin-only portfolio to the BTC-LTC and BTC-XRP pairs, and the Ethereum-only portfolio to the ETH-LTC, ETH-XRP, and ETH-BTC pair.

TWO ASSET EQUALLY WEIGHTED PORTFOLIO

The expected return is the average of the returns from previous years. Because Bitcoin and Ethereum have relatively high expected returns in their single-asset portfolios, when you add either XRP or LTC to the Bitcoin or Ethereum-only portfolios, the lower expected return values of LTC and XRP drag down the overall expected return of the portfolio. For example: 2>1, 1+2=3, 3/2 = 1.5, 1.5 < 2.

That is why the expected returns are lower for every two asset portfolio containing BTC, besides the BTC-ETH pair. In the BTC-ETH portfolio, Ethereum’s average return is higher than Bitcoin’s average return; so when the portfolio’s expected return is averaged, the expected return for the two-asset portfolio is higher than the expected return for the BTC-only portfolio – for example  2 >1, 1+2 =3, 3/2 =1.5, 1.5>1.

The standard deviation associated with a portfolio consisting of two assets is lower than the SD of every single asset portfolio (except when comparing the Ethereum-only portfolio to every other one containing Ethereum or the Litecoin-only portfolio to the LTC-XRP one).

The standard deviation of Ethereum is so low (6.05 percent) that when another asset is added to an Ether-only portfolio, the higher SD of the other asset raises that of the entire portfolio to a level higher than that of an Ethereum-only portfolio.

In the LTC-XRP portfolio, the standard deviation of the portfolio is 4.77 percent higher than SD of a Litecoin-only portfolio (163.6 percent). For most investors, this may be nothing to sneeze at, but it all depends on the level of risk that an investor is able to tolerate.

Three Asset Portfolio

In a three-asset crypto portfolio, the expected returns increase in comparison to every-two asset portfolio.

The standard deviation associated with holding a three-asset crypto portfolio will increase in comparison to every two-asset portfolio except those with LTC-XRP, BTC-XRP, and BTC-LTC, their SD will decrease when you add a third crypto-asset to the portfolio.

THREE ASSET EQUALLY WEIGHTED PORTFOLIO

Four Asset Portfolio

In an equally weighted crypto portfolio that consists of BTC, ETH, LTC, and XRP the expected returns would decrease compared to those of every three-asset portfolio. The maximum decrease in expected return is 232.225 percent and comes from the portfolio that adds Bitcoin to the  ETH, LTC, XRP portfolio, and the minimum decrease in expected return is 119.159 percent and comes from the portfolio that adds ETH to the BTC, LTC, XRP portfolio.

The standard deviation would increase in respect to three out of the four three-asset portfolios, with the only decrease in the SD being in reference to the BTC, LTC, XRP portfolio by 4.91 percent.

FOUR ASSET EQUALLY WEIGHTED PORTFOLIO

So how to diversify away risk in crypto portfolios?

Although digital assets are highly correlated, it is possible to diversify away risk in a crypto-only portfolio by adding more crypto assets to the portfolio. It is possible to diminish standard deviation when you move from a single-asset portfolio to a two-asset portfolio in 3 out of the 6 possible two-asset portfolios; from a two-asset portfolio to a three-asset portfolio – in respect to 3 out of 6 two-asset portfolios, and in a four-asset portfolio – in respect to 1 of the 4 three-asset portfolios.

The reason you are able to diversify away risk in a crypto-only portfolio even though the crypto-assets are highly correlated could be because there are different types of risk, as Sumanov said to Cointelegraph.

“Diversification in a crypto-only portfolio can help with the following:

  1. Single asset risks. Risks of project failing, delisting from exchanges, ban from government, problems with team etc. Huge dump due to a major holder deciding to sell all his holdings one day and many other risks, that are connected  with holding only a single asset. For example, TenX token (ticker PAY) declined a lot in price after Wirex Company declined their contract for cryptocurrency card issuing due to EU regulator.
  2. Connection of portfolio value to average industry growing. If you invest in just single or few assets, it is like playing the lottery. Your assets can perform differently – one could grow fast, and another could just make +10 percent  and that is all. So, portfolio diversification gives you the opportunity to receive profit from the whole market growing and not depend just on having faith in one coin.
  3. You can make different portfolios (for example high-risk, average, low risk) and receive profit that will be “averaged” on risk type.”

Even though digital assets are highly correlated, it is possible to mitigate the amount of risk you are exposed to by investing in multiple crypto assets instead of only one crypto-asset. This is reminiscent of the old adage “you should not put all your eggs in one basket”. By investing in multiple crypto-assets it is possible to spread out the amount of risk you are exposed to instead of having all of the volatility of the portfolio come from one asset. By spreading the risk over several assets, it could be also possible to increase the expected returns of a portfolio while diminishing the amount of standard deviation of the portfolio.

RETURNS OF BTC, ETH, LTC, XRP

When comparing all six two-asset portfolios to the four single asset portfolios, it is possible to increase expected returns in respect to at least one of the single-asset portfolio. Comparing the three-asset portfolios to the two asset portfolios, it is possible to increase expected returns in all four three-asset portfolios, and when comparing a four-asset portfolio to the three-asset portfolios, it seems not possible to increase expected returns in comparison to the three-asset portfolios.

The analysis shows that spreading wealth over a number of assets, instead of putting all into one, could diversify away the idiosyncratic risk that is unique to a particular digital asset, and the more risk one is able to diversify away, the better situated he could be to protect himself against losses in the cryptocurrency portfolio.


Here at Dollar Destruction, we endeavor to bring to you the latest, most important news from around the globe. We scan the web looking for the most valuable content and dish it right up for you! The content of this article was provided by the source referenced. Dollar Destruction does not endorse and is not responsible for or liable for any content, accuracy, quality, advertising, products or other materials on this page. As always, we encourage you to perform your own research!

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