Smart Bitcoin Investment: How Much Should You Invest?

Bitcoin is a decentralised digital currency that operates without the oversight of banks and governments. It is the first and largest cryptocurrency by market cap, and its price has been extremely volatile since its launch in 2009.

Bitcoin's price has seen meteoric growth in recent years, and some analysts believe it could rise even further as cryptocurrency and blockchain technology become a bigger part of people's daily lives. However, it has also experienced devastating declines, making it a risky investment.

So, how much should you invest in Bitcoin? Most financial experts recommend limiting crypto exposure to less than 5% of your total portfolio. Given its position as the largest cryptocurrency, Bitcoin could easily make up a sizable portion of those holdings.

It's important to remember that cryptocurrencies are still relatively new and extremely volatile. The most important rule when investing in crypto is never to invest more than you can afford to lose.

Risk tolerance

Understanding your emotional response to financial losses and considering your long-term goals are crucial aspects of risk tolerance. Turbulence in an asset class may not matter if you're investing for decades, but it could be disastrous if you're saving for a short-term goal like a house or a car.

The crypto market is even more complicated due to its high volatility compared to other assets. For example, in 2017, the total market capitalization of cryptocurrencies soared from $18 billion to over $825 billion in a single year—an increase of almost 4,500%. However, such extreme growth is often unsustainable, as demonstrated by the crypto market crash in 2018, which saw an 80% loss in value over eight months.

Given the high volatility, regulatory uncertainty, and the constant threat of cybercrime in the crypto space, aspiring investors need to carefully consider their risk tolerance. A straightforward way to gauge this is to ask yourself how much money you are comfortable losing. If you're investing directly in cryptocurrencies, keep in mind that they can fall in value as quickly as they rise.

A more conservative approach is to diversify your investment by creating a "basket of coins". This involves choosing some or all of the top 10 cryptocurrencies, or a mix of larger, established coins with some up-and-coming coins that have higher upside potential.

Another option is to invest in the broader blockchain ecosystem, which includes assets like Non-Fungible Tokens (NFTs), Decentralized Finance (DeFi), and blockchain-focused stocks.

It's important to remember that there is no one-size-fits-all approach to investing in Bitcoin or other cryptocurrencies. Your risk tolerance will depend on your financial situation, goals, and emotional response to potential losses.

Profit tolerance

When considering investing in Bitcoin, it is important to evaluate your profit tolerance. This means assessing how you will react to potential gains and losses.

The cryptocurrency market is highly volatile, and Bitcoin's value can fluctuate significantly in a short period. This can lead to substantial gains or losses. Therefore, it is crucial to invest only what you can afford to lose.

• Emotional Detachment: It is essential to invest an amount that you can emotionally detach from. Whether the value of your investment increases or decreases, maintaining emotional detachment will make you a solid investor. You will be able to make rational decisions without letting your emotions influence your judgment.
• Risk and Reward: The potential for high profits also comes with the risk of significant losses. Assess your tolerance for risk and only invest what you are comfortable losing. Greed can lead to poor investment decisions, so it is important to be reasonable and rational in your investment strategy.
• Long-term Perspective: The cryptocurrency market is subject to boom and bust cycles. Short-term price surges may be followed by market crashes. Therefore, it is important to have a long-term perspective and not make impulsive decisions based on short-term price movements.
• Diversification: Diversifying your investments across different assets, such as stocks, real estate, or other cryptocurrencies, can help manage your overall risk. It is generally not advisable to invest all your savings in cryptocurrencies due to their volatile nature.
• Reinvesting Profits: Reinvesting your profits back into Bitcoin or other cryptocurrencies can be a strategy for long-term growth. This approach allows you to compound your gains and build your crypto holdings over time.
• Risk Management: Developing a robust risk management framework is crucial for any investment, including Bitcoin. Assess your financial health and ensure that your investment amount is within your capacity for loss. It is generally recommended that high-risk investments like cryptocurrencies should not exceed 10% of your investment portfolio.

In conclusion, when considering how much to invest in Bitcoin, carefully evaluate your profit tolerance by assessing how you would react to potential gains and losses. Maintain emotional detachment, practice risk management, diversify your investments, and reinvest profits wisely to build your crypto holdings over time.

Volatility

Bitcoin is considered a volatile investment asset. Volatility refers to how much the price of a financial asset varies over time. It is a measure of the dispersion of returns, typically calculated as the standard deviation.

The volatility of Bitcoin is measured by how much its price fluctuates relative to the average price over a given period. Bitcoin's volatility is influenced by speculation and bets placed by crypto investors. As a result, its price can suddenly increase or decrease, leading to volatile market behaviour.

Bitcoin's volatility is tracked by the Bitcoin Volatility Index, which was sitting at 3.07% at the start of the week of 22nd August 2024. This is considered fairly volatile, but it depends on what other cryptocurrencies you compare it to. For example, gold has an average volatility of around 1.2%, while major currencies average between 0.5% and 1.0%.

Bitcoin's volatility has been declining and is expected to continue doing so as the asset class matures. In fact, Bitcoin has been less volatile than some prominent individual securities, such as Netflix stock.

How Much to Invest in Bitcoin

Given the volatility of Bitcoin, it is important to only invest what you can afford to lose. The amount you invest should depend on your risk tolerance and the amount of money you can afford to lose.

It is recommended to invest somewhere between 5% and 30% of your investment capital in Bitcoin. Investing 5% is considered very safe, while 30% is considered pretty risky.

It is also a good idea to diversify your investments across different asset classes, such as real estate, stocks, and gold.

Before investing in Bitcoin, be sure to research the legal, regulatory, and tax status of purchasing it in your country or state.

Diversification

According to a Yale University study, portfolios should include about 6% Bitcoin to achieve optimal construction. Even those who are sceptical of cryptocurrencies should maintain at least a 4% BTC allocation, and investing 1% of assets in BTC can be a prudent diversification strategy.

However, the diversification benefits of Bitcoin may decrease as it becomes more mainstream. JPMorgan strategists argue that as Bitcoin becomes more widely adopted, its correlation with other assets increases, reducing its effectiveness as a diversification tool. They suggest that allocating up to 2% of a portfolio to crypto can improve efficiency, but investors should reassess as crypto becomes more correlated with other assets.

When deciding how much to invest in Bitcoin, it is essential to consider your risk tolerance, profit expectations, and overall financial goals. It is recommended to invest somewhere between 5% to 30% of your investment capital in Bitcoin, with 5% considered very safe and 30% quite risky. It is also important to remember that investing in cryptocurrencies is highly speculative and subject to high volatility.

To summarise, diversification is a vital aspect of investing in Bitcoin. By allocating a suitable percentage of your portfolio to Bitcoin, you can potentially enhance returns while managing risk. However, it is crucial to stay informed about market trends and adjust your strategy as needed.

Budgeting

Determine Your Financial Health:

Before investing in Bitcoin, it's important to assess your financial health and ensure you're on solid ground. Start by paying off any high-interest debt, such as credit cards or personal loans. The interest on these debts can quickly add up, making it challenging to get out of debt.

Build an Emergency Fund:

It's recommended to have an emergency fund that can cover your expenses for three to six months. This fund will provide a safety net in case of unexpected expenses or financial setbacks, giving you peace of mind and ensuring you don't have to dip into your investments prematurely.

Diversify Your Investments:

Don't put all your eggs in one basket. Consider diversifying your investments by contributing to a 401(k) or a Roth IRA for retirement. These options offer tax advantages and can help you save for the long term.

Calculate Your Income and Expenses:

To create a budget, you need to know your income and expenses. Calculate your total income from all sources, including your salary, investments, or any other side hustles. Then, list out your regular expenses, such as rent, transportation, utilities, and groceries.

Choose a Budgeting Method:

There are several budgeting methods you can use to track your expenses and income. You can go old-school and manually write everything down or use a spreadsheet. Alternatively, you can utilise budgeting apps or the features provided by your banking app to automatically categorise and track your spending.

Decide on an Investment Amount:

Once you have a clear picture of your financial situation, decide on an investment amount that you're comfortable with. Remember, investing in Bitcoin is risky, so only invest what you can afford to lose. It's generally recommended to invest somewhere between 5% to 30% of your investment capital, with 5% being very safe and 30% being pretty risky.

Reevaluate and Adjust:

Remember, investing in Bitcoin is a risky endeavour, and it's crucial to do your research and understand the market before committing any funds. Always consult a financial professional for personalised advice regarding your investment decisions.

Frequently asked questions