Every up-and-coming investor faces the same problem when they start investing: how to maximize profits while minimizing risks?

No one wants to give up profits, yet all investors know that capital preservation is imperative. Especially newcomers find themselves caught in two minds about this. That wouldn’t be so bad if there were an easy shortcut or general rule on how to get there. Unfortunately, there is not. But without a plan, investors will find it hard to balance these two priorities.

Formulating a universally valid blueprint for investment is beyond this blog post. But you will learn how to develop a simple yet effective plan for building a portfolio that achieves profit maximization and risk minimization. The following five steps will get you 90% of the way to building a well-balanced, profitable portfolio.

Define your priorities and risk tolerance

Some people prefer playing it safe. Others have no issues with taking on a lot of risks. Investors always seek maximum returns, but while the risk-averse investor might be content with 5% a year, the risk-affine investor could be disappointed with 50%.

You’re the best judge of your personal finances. You alone know how much risk you feel comfortable with. You are also the only person that can define the priorities and timeline: is the portfolio supposed to preserve capital, or are you trying to build an aggressive investment position? Do you have other assets that, like real estate, that influence your cash flow and investment decisions?

Be aware: risk and return have a trade-off. You cannot have triple-digit annual returns on crypto without holding through 70% drawdowns. That is why so many people shy away from crypto. They cannot bear the thought of seeing their investment down heavily. But those that are patient enough and prioritize massive returns over safety can see big rewards.

Define your asset class

If you’re reading this, you’re likely looking to get into crypto or add to your position. But you do not have to pick crypto or only crypto. Instead, focus on what you know well: stocks, bonds, commodities, or crypto. It’s easier to make sound investment decisions if you know your way around an asset class and are familiar with what strong performance requires. Once you know that, define the asset class you want to invest in.

Even within asset classes, you can define your investment choice more precisely. If you are a heavy DeFi user, you might want to get into DeFi coins. Maybe you’re into NFTs and know that space well enough to pick promising projects. Within crypto, there is not too much diversification yet, so more or less all coins are going to move with Bitcoin to some degree. However, that will change at some point. As long as you have a working knowledge of your assets, you should be good.

Define if and how you want to diversify

Capital allocation means where you put your money. Capital diversification means putting your money in different places to spread your risk.

According to modern portfolio theory, you should diversify your portfolio and invest in uncorrelated assets. If you are in Bitcoin, you shouldn’t also get into Ethereum because those are strongly correlated. Buying bonds would be a better choice in that case.

However, diversification comes with a cost. First, you will spend more time with a diversified portfolio. Managing and monitoring ten different assets is more time-consuming than managing two assets. Second, a diversified portfolio is safer but has less upside. If you put all your money in Bitcoin and Bitcoin goes up, you are doing better than diversified investors. But remember that your investment was far riskier than a diversified one.

Even within crypto, you can diversify somewhat. You could maybe have such an allocation:

50% Bitcoin

25% Stablecoins

15% Ethereum

10% Altcoins

That would be a fairly safe portfolio for crypto standards. If you prefer more risk and are comfortable with more volatility, you could add more to your altcoin position at the expense of Bitcoin or stablecoins.

Monitor your investments

Once you defined your priorities and made your investments, you need to track and manage them. Luckily, there are many portfolio trackers out there that pretty much do the work for you these days. You can use a tool like Coinmarketcap, Coingecko, or Cointracker to have constant access to your portfolio’s performance. While you shouldn’t overdo it by checking your portfolio several times a day, it’s recommended to watch your investments with eagle eyes in crypto. The markets are famously volatile, and you don’t want to get caught by a flash crash.

Manage your portfolio

Tracking your investments is only half the work. The real challenge is managing them correctly. If you correctly defined your priorities at the beginning, you shouldn’t have too many problems with this. That means having a plan in case Bitcoin goes up 25% or down 35%. You should not be in a position where you have to make decisions on the fly.

Part of managing is also potentially rebalancing your portfolio or adding new investments. If one of your altcoins performed exceptionally well, it isn’t the worst idea to take some profits and rebalance your portfolio. You can allocate this new capital somewhere else.

You can also consider balancing your portfolio with other investment strategies like yield-farming. Passive income from cryptocurrencies is still considered investing and can be a good strategy to balance riskier assets that you are holding.

Conclusion

Diversification and profit maximization has been the topic of many studies and scholars ever since humans started investing. Instead of causing yourself a headache over the best ratios and allocations of your capital, you should try to think in terms of the mental models presented in this post. That will take out a lot of stress from the investment process and help you become a shrewder investor and generate more profits down the line.

At VRM, we provide regular investment analysis about the cryptocurrency markets in cooperation with our trading department. Check it out and don’t miss the newest trends and developments in the crypto space.