Diversification is one of the most crucial aspects of a well-balanced portfolio. In the past, this meant investing in traditional assets such as stocks and bonds. Over the last few years, new asset classes have risen for investors to consider in their portfolios. Cryptocurrency is one of these new classes, but due to its high volatility, it has been the subject of much scrutiny.
New methods for diversification of cryptocurrency have been created, however, with cryptocurrency indexes being the most recent. Choosing to invest in a cryptocurrency index can allow you to spread out and mitigate your risk with this alternative investment.
What is a Cryptocurrency Index?
Understanding how you can reduce risk with a crypto index starts with learning what exactly an index is. Whether it’s stocks or cryptocurrency, an index is a financial vehicle that invests in a group of assets at once using a pool of funds from investors.
For example, if a person chooses to invest in the S&P 500, they are choosing to invest in an index that tracks the largest 500 U.S. Companies. A cryptocurrency index does not include stocks but rather a group of individual cryptocurrencies that are meant to mirror the performance of the entire crypto market.
What Does a Cryptocurrency Index Track?
The crypto coins included in a cryptocurrency index vary depending on each specific index. As of right now, the concept of a cryptocurrency index is still fresh, which means most indexes will simply include some of the largest coins in their portfolio. As this concept evolves, cryptocurrency indexes may also evolve to track more complex assets in this class.
Pros and Cons of a Cryptocurrency Index
As with any investment, there are a number of pros and cons to consider:
Pros of a Crypto Index
- Unique asset class partially separated from impacts of stock market
- Diversified investment tool amidst a volatile asset class
- Requires no individual asset research on behalf of the investor
Cons of a Crypto Index
- Potentially higher cost, with a 2.5% expense ratio being average
- Still exposed to the high level of volatility in the cryptocurrency market as a whole
With any investment, it’s important to run a cost-benefit analysis to help determine if that investment is right for you. Consider the money you’re putting in and what the potential risk and reward might be. Find the sweet spot where you feel comfortable knowing what you might lose and what you might gain.
Of the many different investment strategies, index investing is one of the most popular. Consider also cost-dollar averaging into whichever crypto index you choose by investing small amounts on a consistent basis, such as weekly or monthly. This can further mitigate the risk of volatility.
Diversify your investments today
Cryptocurrency is undoubtedly riskier than other assets you may consider adding to your portfolio. This volatility can make choosing which cryptocurrencies to add exposure to in your portfolio different. Consider using a cryptocurrency index if you don’t want to bother with researching each individual cryptocurrency and would like to mitigate risk. As with any investment, an index does not guarantee profits or losses.