How to Manage your Cryptocurrency Portfolio

Why do you want to invest in cryptocurrency?

Many people answer straight away – I want to earn money. So, the question is why do you want to achieve this using crypto?

To answer this question, we will go through the 1st pillar of the Cryptocurrency Investing Framework, which is Portfolio Management.

We will go through the six steps End-To-End Investment Process, starting with creating our vision.

Vision - What is the Goal?

Goals are about the results that we want to achieve.

What is your Financial Goal? Defining it as being wealthy isn’t very precise. People understand it differently:

• I want to have X money when I retire.

• I would like to get X of monthly cash flow.

• Average returns from capital is higher than X.

• I don’t want to have a worse return than benchmark X.

Where X is up to you. It could be any figure.

I like to define financial goals as the ability to preserve (prevent capital loss) and compound wealth (increase purchasing power) to assure financial security & freedom. For better understanding, we need to define wealth.

Wealth

What is wealth? For me, it’s freedom of being independent of limiting factor money, which is a vehicle to transfer wealth.

Financial Wealth is wealth related to money, including promises to pay money and the capacity to sell things for money. Financial wealth is relevant to inflation because it confers spending power.

Real Wealth is wealth related to the real goods and services that people want, including the capacity to produce those goods and services. Real wealth is relevant to inflation because it's how spending power is fulfilled.

To better understand the difference between the financial and real economy, I would recommend you check this video.

In our Financial Goal section, we mentioned that we should be able to preserve our wealth. Let’s then check what type of enemy do we have.

The Reason for Investing

We have one main reason for investing – Inflation. The best way to understand it is to look at the below charts, how money is changing its value in time (100% is currency to the gold ratio in the first year):

1. How reserve currencies are devaluating vs gold across 400 years?

2. How did currencies are devaluating vs gold in the last century?

Dalio, Ray. 2020. The changing world order where we are and where we’re going.

The trend is clear, but if this does not convince you, check also how CPI is related to some expenses across the time:

Even if we wouldn't have inflation (Broad CPI), we have to compound our wealth to maintain purchasing power at the same level.

Portfolio Assessment -> Where am I Now?

We know what we want to achieve now. It’s also worth understanding where we are standing right now. Let’s then check our current financial situation:

• What financial assets do we have?

• How our real and financial income is changing?

In this article, we will focus on financial assets.

The best way to do this assessment is to create an inventory of what you have. This inventory will be used later to manage our portfolio, so it’s worth spending some time on it.

There are several tools available to do so, but what works best for me is Excel or Google Sheets, whatever you prefer.

Therefore, I created an example spreadsheet for you, which you can adjust according to your needs. You can download it HERE.

Portfolio Tool

In the first tab, you have a description of all proposed columns to describe your portfolio. You can add more later if needed.

Now, what should be considered as a financial asset? Let's use the below rules to evaluate what can we add there:

• Value – This should be valuable for others (we have demand for this asset)

• Liquidity – There should be a market for it, which allows you to sell it. I am not adding my home, car, or kidney however they have value for others and probably I can find a market for it. If you are trading cars, let's add them. If you have many houses, add them. I like to think about it, that if someone will give me the value in cash for any listed item with little premium (it should also include potential taxation, but let’s keep it simple), I will sell it.

The main Assets Classes to consider are:

• Cash

• Bonds

• Equities

• Commodities

• Precious metals

• Real Estates

• P2P loans

• …And cryptocurrencies

Finally, we get into crypto! Later, we will consider when it makes sense to add cryptocurrency to your portfolio and when you should focus on other assets.

Once you are done with your portfolio assessment, you’ll see where you stand. Let’s then precisely define our goal.

Portfolio Goals -> Where Do I Want to Be?

To better define our financial goal, we will use this simple equation:

Salary + Capital Changes = Assets and Liabilities

Salary (Real Economy) – money contribution given in exchange for your time in the real economy (for most people is just a job)

Capital changes (Financial Economy) - your capital can be decreased by wrong investment decisions or specific market situations. It’s also decreasing over time due to inflation. Successful investment by the other way is increasing your capital

Assets – Real and financial things that increase your capital over time (we just added them to portfolio)

Liabilities - Things that do not generate your interest or are illiquid (due to your decision or nature)

So, in order to increase your wealth (assets and liabilities), you can increase your salary or income from wealth. Let’s dive deeper into this.

To increase salary, you can get a promotion or change job, etc. The main KPI here to consider is salary/h. This is not part of this article, but you can find more details on the 80000 Hours website.

To increase the rent from the capital, you need to have more assets, as liabilities don’t produce cash flow and you can’t sell them for a higher price in normal market conditions, or get a better return from them.

We also need to consider an additional measure which is time. You can also automate what you are doing now (maybe just buy ETF instead of spending time finding the best stocks) to decrease time, and ultimately increase financial income/h.

Investor’ Path

Now the questions arise:

1. Should you invest to increase your capital rent vs focusing on your job to increase your salary/h?

2. How much should you invest in crypto?

The first question is the hardest. We can compare and simulate changes in your salary or capital rent, but you should also consider less quantifiable factors. Again, 80000 Hours is the best source to start. Assuming that investment is for you, we can move to the second question.

Crypto is just one of many assets classes. Each of them has different parameters and this is the reason why they are distinguished within different classes.

Some of the asset’s parameters to consider (list is not exhausting and can be adjusted to current needs):

1. Economic Growth – How do changes in economic growth impact your returns?

2. Inflation – How do inflation and deflation impact your returns?

3. Trustlessness – What are assets’ issuance policy and transaction finality? Can it be manipulated by a third party?

4. Liquidity – What is the liquidity rate of the asset?

5. Region – Is the return tightly coupled with any region or area?

By comparing them, you will find the best assets to contribute to your goal, or even better – a mix of the assets. We will dive deeper into this in the Assets Allocation section from the 2nd pillar of the Cryptocurrency Investing Framework.

If the investor path is for you, let’s discuss our strategy.

Portfolio Strategy -> How do I Get There?

Now we know why we are doing this, where we are, and what do we want to achieve. Let’s move to create a Strategy. This is the 2nd pillar of Framework – Research & Development, but let’s highlight it here.

Winners and losers have the same goal. They differ in strategy to achieve them. To achieve your goals, you will need:

• Time

• Money

• Skills

Many of these parameters are interchangeable, depending on your choice and current situation.

To create and implement your strategy, you will need to have some specific skills, depending on previously discussed factors. You can acquire this by spending your time or using money to accelerate learning. Probably you will also need some data, reports, tools, etc.

Investing is both simple and difficult at the same time. Many of your choices can be evaluated after a few years. This is the reason why it's hard to stick to your strategy or follow one of the Famous Investor Strategies To Invest and Lose Your Money (don’t look for this book – I’ve created this name).

Guess, what will happen if you invest your money in stocks and a few weeks later the economy collapses? You will have to wait many years when stock prices return to the same level. How this will impact your further plans? Of course, you don’t know what will you do and how this will affect you. Think more about the potential scenario. Can I delay buying my home by X years?

What if you invest in cryptocurrency and we will have another bear market where a good project will lose up to 80%? Their values are going almost to zero. You can check the performance of old projects on CoinMarketCap. For many of them, the trend is clear. They are going to zero.

In the 2nd pillar of the Framework, we will also be using Risk Management to mitigate some (hopefully all) of the potential risk. Let’s consider now how to choose an Investment Strategy.

Different strategies

We can start with defining two parameters, which will be used to evaluate our strategy:

1. Return Objective - Determine needed average return from invested capital

2. Risk Appetite - As low as practical to achieve the objective. You can also specify kurtosis and skewness parameters (I am not a big fan of doing it, because the market is a complex system).

We have a huge impact on these parameters, mainly due to Assets Allocation. You can see this on the chart below, where we have returns from different asset classes for the last 200 years.

https://modelinvesting.com/content/uploads/2015/06/Total-Real-Return-by-Asset-Class.jpg

You can find many similar charts on the web with different returns for those asset classes, depending on their definition and time period. You can also check it by yourself, using Portfolio Visualizer and playing with different parameters.

Anyway, the conclusion is clear – Stocks (including REITs) give you the highest returns with the highest variability. This is in line with Effective Market Hypnotehis.

Bitcoin and other cryptocurrencies have a shorter track record, so we have to shorter our time period to add it. Let’s check the below chart comparing returns for the best-performing investments.

The image is from here.

Again, high volatility, high returns. Ask yourself - What is the highest variability that you can tolerate alongside minimal return that can help you achieve your goals?

This will tell how aggressive you should be, what should be your starting capital, how much you can withdraw or should deposit to achieve your goals.

Of course, we cannot predict the future, but this exercise will tell you how achievable your goal is.

• Is it possible to achieve goals only by investing in stocks?

• Can I tolerate the risk of putting 50% of my money into cryptocurrency?

• When I will achieve my goals assuming that I will invest 10% of my salary?

Take your time and think about it because it will vastly impact your strategy. What I will recommend to you in the next articles is to diversify across many assets, especially combining stocks with crypto.

Now assuming that we have our strategy, it’s time to stick to it and take all needed actions.

Strategy Implementation - How to Do This?

Implementation is the 3rd pillar of the Cryptocurrency Investing Framework. This part is simple if you like to teach someone, but hard to practice same as trying to stay fit. Almost everyone knows what to do, or at least what not to do. After all, execution is a much harder part.

The most helpful thing here will be your experience and strategy (fortunately we have a dedicated pillar for it):

1. The first piece of advice is to educate yourself to get confidence, so that your strategy can work (we never know whether this works if, but having a good one significantly increases our chances).

2. The next advice is to lower the stake. Most of us tend to understatement our Risk Tolerance. Therefore, start with the money that you can afford to lose, where you can also experiment to better understand your behavior.

Investor Journals can be helpful for this. You can put there all your financial decision with explanations – Why did I do this? What I was expecting? How did I feel?

This will later be helpful to evaluate and track your progress.

We will also have to learn a bunch of different skills, frameworks, and Mental Models that will help you achieve your goals. It’s time to dive into psychology.

Investor Psychology

As an investor, we don’t control returns, especially in short term, but we have an impact on risk and our behavior. We are deciding on a balance between losing money and opportunism (gains).

To win in this game, we have to better predict the future than other investors and be aware of our Mental Errors:

1. Analytical/Intellectual (too little information, incorrect information, wrong analytical process)

2. Psychological/Emotional (greed and fear, ego and envy, willingness to suspend disbelief and skepticism, the drive to pursue high returns through risk-bearing, tendency to overrate one's foreknowledge, extrapolating past)

The best way to minimize the impact of Mental Errors is to be aware of the fact that all of us are affected and we have frameworks to reduce our biases. This will allow us to answer below questions:

1. How to decide when buying something?

2. Should we sell with a penalty or buy more, if our investment is going in the opposite direction?

3. How to calm down ourselves upon watching a huge drop in our portfolio value?

4. How to prevail against FOMO and not check our investment every day or even a few hours…?

We will learn all of this later, but now let’s check how to evaluate our strategy.

Strategy Evaluation - Did I Get There?

How to check that you have a good strategy, or maybe it needs some updates? Or that you possess the required skills to achieve your goals?

We need an Evidence-Based Evaluation that tells us if we are progressing in the chosen direction.

We will evaluate our performance and what we learnt. This will be the input to our Investment Strategy and Learning Path.

How can we define our end goals to be able to track them and later evaluate our strategy? We need to know there we are going in a good direction, so I propose you to create some milestones towards our goal.

Let’s now move to the evaluation process.

Evaluation Process

The review process can be triggered by time or external events.

At each point in time, we will have a specific amount of wealth. The difference between these time intervals gives us a return from the portfolio (assuming no deposit and withdrawals). This is a key metric that we will be tracking.

Another is variability. We can define it in many ways, but it should tell how changes in our portfolio differ from this annual return.

We should also have many different evaluation periods which can be adjusted to our needs and current situation. You can change this later, but I am proposing you to start with:

• Annually

• Changes related to taxation

• Strategy Evaluation

• Goal Evaluation

• Monthly/Quarterly

• Deposit/Withdrawal

• Portfolio Monitoring

• Weekly

• Portfolio Monitoring (Fast-changing assets like crypto)

I am creating a new sheet for each review period in my tool, to have a snapshot of past data, to analyze it later.

We will go deeper into each of those reviews processes in the 4th pillar of the Cryptocurrency Investing Framework.

What Next?

We just review topics related to portfolio management to be able to:

1. Define our expectations regarding investment.

2. Asses our financial situation.

3. Define our portfolio goals.

4. Understand why we need a strategy, how to use it, and evaluate.

In the next article we will create our Investment Strategy, so be sure to have your portfolio up to date. You can start with this template.

Stay tuned and follow me on Twitter to get a sneak peek of what is coming!