Small Investments, Big Rewards: Cryptocurrency For Beginners

Cryptocurrency is a highly speculative and volatile investment, and many smart investors choose to put their money elsewhere. However, for beginners who want to start trading crypto, it is advisable to start with small amounts. Before investing in cryptocurrency, it is important to understand the investment case for each trade, as many cryptocurrencies are backed by nothing and rely exclusively on someone paying more for the asset than the investor paid for it. It is also important to remember that past performance does not guarantee future results, and investors should always look forward, not back, when considering an investment. Volatility can be a challenge for new investors, as it can lead to emotional decisions that sophisticated investors can take advantage of. Therefore, it is crucial to understand how to manage risk and develop a process to mitigate losses. Finally, it is recommended not to invest more than one can afford to lose, as the crypto market can be unpredictable.

Understand what you're investing in

Understanding what you're investing in is a crucial step in the process of investing in cryptocurrency. Here are some key considerations to help you make informed decisions:

Do Your Research

Firstly, recognise that there are thousands of cryptocurrencies, and they all function differently. New cryptocurrencies are being created every day, so it's important to stay informed about the latest developments. Understand the investment case for each trade, and be aware of the potential upside and downside. Read up on whitepapers, which are documents that explain the purpose and technology behind each cryptocurrency.

Backed Assets or Cash Flow

Note that many cryptocurrencies are backed by nothing—neither hard assets nor the cash flow of an underlying entity. For example, Bitcoin investors rely exclusively on someone paying more for the asset than they paid for it. In contrast, stocks of a company can grow their profits and drive returns for investors. Therefore, many crypto assets depend on the market becoming more optimistic and bullish for investors to profit.

Popular Cryptocurrencies

Some of the most popular coins include Ethereum, Dogecoin, Cardano, and Solana. Understand the unique characteristics and value propositions of each cryptocurrency before investing.

Volatility

Cryptocurrencies are highly volatile, experiencing daily ups and downs, including steep short-term changes. This volatility can be a double-edged sword, offering opportunities for profit but also carrying the risk of significant losses. Be prepared for a rollercoaster ride, and ensure you can endure the potential ups and downs without letting emotions dictate your decisions.

Security

Prioritise the security of your investments. Consider investing in a crypto wallet to hold your coins offline, making them inaccessible to potential hackers.

Don't focus on past performance

When investing in cryptocurrency, it's important to remember that past performance does not guarantee future results. This is true of any stock, fund, or even the overall market itself. Many funds have delivered strong performance for a year or several years, only to fizzle out and fail over time.

For example, the ARK ETFs, notably ARKK, delivered over 150% returns in 2020 and outperformed the S&P 500 in 6 out of 7 years. However, it is unlikely to beat the market in the long term. Another example is the CGM Focus Fund (CGMFX), which was the top-performing fund from 2000 to 2007, outperforming the S&P 500 and every other actively managed mutual fund. However, it eventually underperformed and incurred dramatic losses.

Therefore, it's crucial not to get caught up in chasing past performance. Instead, conduct thorough research, understand the investment case for each trade, and focus on the potential for future gains rather than what an asset has done in the past.

When investing in cryptocurrency, it's essential to remember that it is a highly volatile and speculative market. Cryptos such as Bitcoin have experienced tremendous boom-and-bust cycles. As a new investor, it's crucial to understand the risks and develop a risk management strategy.

Remember, investing in cryptocurrency should be done with money you can afford to lose. It's a speculative investment with a major learning curve, and it's important to understand the risks and potential downsides before diving in.

Be cautious of volatility

Cryptocurrency is a highly volatile asset class. This means that the prices of cryptocurrencies can fluctuate wildly and are susceptible to steep short-term changes. For example, in a two-week span, the value of bitcoin experienced a large increase, followed by a sharp decrease. This volatility can be exciting for investors, as it provides opportunities for profit, but it is also a significant risk.

Volatility can be especially challenging for new investors, who may not have the same level of knowledge or experience as more sophisticated investors. It can be difficult to know when to buy and sell, and the emotional cost of managing risk can be high. Volatile assets like cryptocurrency require a strong risk management strategy, such as setting strict rules on when to sell or limiting the amount of money invested.

Additionally, the frequent trading that volatility encourages can be time-consuming and emotionally taxing. It is important for investors to understand their own risk tolerance and comfort level with the frequent trading that the volatile nature of cryptocurrency may require.

Volatility can also impact the overall performance of your investment portfolio. If you are investing a large amount in cryptocurrency, a major loss could derail your progress toward financial milestones, such as retiring.

For these reasons, it is generally recommended that investors start with small amounts when investing in cryptocurrency to gauge their comfort level with the volatility and to limit the potential impact on their portfolio.

Manage your risk

Before investing in cryptocurrency, it's important to understand the risks involved and how to manage them. Here are some tips to help you manage your risk when investing small amounts of money in cryptocurrency:

Understand the volatility

Cryptocurrency is a highly volatile market, with prices fluctuating wildly in a short period. This volatility can be challenging for new investors, as it can lead to significant losses if not managed properly. It's essential to recognize that this volatility is a game for sophisticated investors with high-powered algorithms that can execute trades rapidly. As a new investor, you need to be cautious and understand how to navigate this volatile market.

Start with small amounts

When investing in cryptocurrency, it's advisable to start with small amounts. This approach allows you to get comfortable with the way cryptocurrencies trade and gauge your risk tolerance. By starting small, you can test how you handle the volatility without risking a significant portion of your portfolio. If you find that you're comfortable with the ups and downs, you can gradually increase your investment.

Have a long-term perspective

One way to manage risk in cryptocurrency investment is to adopt a long-term perspective. This means holding onto your investments for the long haul, even when prices fluctuate. By taking a long-term view, you can ride out the short-term volatility and focus on the potential for growth over time.

Diversify your portfolio

Diversification is a crucial risk management strategy in any investment, including cryptocurrency. Instead of putting all your money into one coin, spread your investments across multiple cryptocurrencies. This diversification helps to reduce the impact of any single coin's performance on your overall portfolio. Additionally, consider investing in a mix of established and newer coins to balance risk and potential rewards.

Don't invest more than you can afford to lose

This principle applies to any speculative investment, including cryptocurrency. Only invest money that you can afford to lose without impacting your financial stability. Avoid using funds allocated for essential expenses, such as rent or mortgage payments, or savings for emergencies. Remember that cryptocurrency is a highly volatile market, and there is always the potential for significant losses.

Only invest what you can afford to lose

Investing in cryptocurrencies is a highly speculative endeavour, and it is crucial to recognise that these assets are extremely volatile and prone to wild price swings. As such, the golden rule of investing in crypto is to "only invest what you can afford to lose". This principle is vital for novice investors to grasp and internalise. Here are some insights to help guide your investment strategy:

• Understanding Risk Tolerance: Before investing, it is imperative to assess your risk tolerance. If you cannot withstand the potential total loss of your crypto investment, then you cannot afford to take on that level of risk. In practical terms, this means investing only the money that won't significantly impact your lifestyle or harm your financial stability.
• Gradual Investment: Consider starting with a small portion of your earnings and setting a monthly budget for crypto investments. This approach ensures that even if you lose all your money, your overall financial situation remains secure.
• Diversification: Diversification is a fundamental strategy in investing. Instead of putting all your eggs in one basket, spread your investments across different cryptocurrencies and exchanges. This helps to reduce your overall risk profile. For instance, you could invest in a stablecoin, a proof-of-work coin like Bitcoin or Ethereum, and an environmentally friendly coin.
• Long-Term Focus: Crypto is infamous for its volatility, but long-term investors often gain massive profits by holding their coins. Avoid getting caught up in the fear of missing out or chasing fleeting gains. Instead, focus on the long-term potential of your investments.
• Informed Decisions: Make sure you are always aware of what you are investing in. Research the fundamentals of the cryptocurrency, including its utility, transaction speed, network security, coding language, and competitive advantages over other cryptos. Additionally, assess the real-world adoption potential and review the team behind the project.
• Dollar-Cost Averaging: Consider using dollar-cost averaging for your crypto investments. This involves making small, recurring purchases on a set schedule, such as weekly or monthly. This strategy helps you build your position over time, reducing the impact of volatility and eliminating the need to time the market perfectly.
• Security: Prioritise the secure storage of your crypto assets. You can use hardware wallets (like Trezor or Ledger), software-based wallets (such as Electrum), or trusted crypto custodian services to protect your investments from hacks, fraud, and lost private keys.
• Emotional Management: Managing your emotions is crucial in the crypto world. Fear of loss and greed are common pitfalls for traders. Do not blindly follow trends, and always conduct your own research to make informed decisions.
• Portfolio Allocation: Most financial experts recommend limiting your crypto exposure to less than 5% of your total portfolio, especially if you are new to crypto investing. This helps to manage overall volatility and risk.
• Tax Implications: Be mindful of the tax obligations associated with crypto investments. Cryptocurrencies are typically treated as property, and capital gains and losses must be reported whenever you sell or trade these assets. Keep detailed records of all crypto transactions to fulfil your tax responsibilities.

Remember, investing in cryptocurrencies is a complex and risky endeavour. "Only invest what you can afford to lose" is a sound principle, but it should be supplemented with a long-term perspective, diversification, and informed decision-making.

Frequently asked questions