Maximizing Returns: Rebalancing Your Crypto Portfolio
Rebalancing an investment portfolio, whether it includes digital or other assets, is an operation that every investor or trader should consider. It can have a significant impact on the overall composition of the portfolio, particularly if done at the right time and under favorable market conditions.
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Let's consider an example of a crypto investor who allocates their funds (in stablecoins or fiat) into four different assets, each representing 25% of the portfolio. Over time, due to fluctuations in the value of these assets, they may experience varying rates of return or loss. As a result, the portfolio balance may shift, with certain assets outperforming or underperforming others. At the end of a given reporting period (which investors often determine for themselves, commonly on a quarterly basis), the portion of each asset in the investment portfolio may amount to, hypothetically, 30%, 20%, 10%, and 40%. This means that two assets have generated profits, while the other two have resulted in losses.
A crypto investor now has two choices:
- Maintain the current portfolio structure until the end of the reporting period (next quarter, half-year, or year).
- Review and adjust the structure and composition (balance) of the investment portfolio.
The first choice may not appear logical or proactive, as it reflects a reluctance to alter the current situation. It may necessitate a thorough analysis of each asset and making informed decisions on future investments. On the other hand, the second option involves rebalancing the investment portfolio.
Understanding digital asset portfolio rebalancing
Rebalancing is a periodic or occasional reassessment of the investment portfolio's composition.
The cryptocurrency market is characterized by high dynamics, volatility, and constant change. Macroeconomic and corporate events occur daily, affecting the characteristics of investment assets such as value, profitability, risks, liquidity, attractiveness to investors, regulatory impact, and more. As a result, the parameters of a crypto portfolio can become unstable over time.
When constructing a crypto portfolio, investors typically align it with their goals, specific criteria, and characteristics. However, as the prospects of certain assets may improve or deteriorate, and some assets may become too risky, it is important for investors to periodically review the contents of their portfolio and rebalance it.
The rebalancing of a portfolio can be achieved through two main methods:
- Selling overperforming assets and buying underperforming assets with growth potential, including the sale of unprofitable coins;
- Restructuring the composition of assets, which means altering the balance between cryptocurrencies with low and high-risk factors, switching to other stablecoins, and so on.
The frequency of rebalancing: How often should the portfolio be adjusted?
Urgent or immediate portfolio rebalancing is typically done based on the completion of a market cycle or a significant change in market trends. However, it should only be undertaken after a comprehensive analysis of technical charts and consideration of fundamental factors.
This approach is suitable for active portfolio management and can potentially provide higher profitability. However, it requires consistent monitoring of market news and trends, as well as timely adjustments to the portfolio.
Scheduled or planned rebalancing is the process of adjusting an investment portfolio at a fixed interval of time, such as monthly, quarterly, half-yearly, or yearly, based on the chosen trading style or investment strategy. Beginners may find it challenging to determine the appropriate time interval, so it is recommended to start with a shorter frequency and gradually increase it as needed.
In any case, it wouldn't hurt to carry out rebalancing at least once a year to review the portfolio structure and update key parameters and asset indicators. Otherwise, important market changes that affect the profitability of the investment portfolio may be missed.
It should be noted that market events are ambiguous, and the consequences of specific news or market reactions caused by FUD or FOMO may not always be predictable.
Another potential risk is overtrading, which can occur when excessive portfolio adjustments result in losses due to strategy errors and high trading fees paid to cryptocurrency exchanges.
A prudent approach would be to combine both methods, where the investor follows a specific schedule and conducts rebalancing at fixed time intervals, while also resorting to unscheduled portfolio restructuring if there are significant changes in the market.
Final words
During an uptrend, an unbalanced portfolio can be profitable, but during a flat or bearish cycle, rebalancing the portfolio may prove to be more efficient.
Rebalancing an investment portfolio primarily reduces risks, rather than increasing its profitability. However, sometimes it can yield significant dividends if a weak asset is replaced with one that has the potential for a 10X return.
The more volatile the market, especially in the case of cryptocurrency, the greater the impact of rebalancing. It is advisable to conduct this operation at least once a year, but the timing of it is entirely up to the investor to decide.
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