Diversification, Financial Well-being and Planning for Your Future
Saving for your future has never been more challenging. With trust in financial institutions and governments plummeting, even smart investors can be uncertain how to generate returns – and, as importantly, how to keep them.
This article is for information only and isn't intended to be taken as financial advice. While this is the kind of statement you'd normally find left in a disclaimer at the beginning or end of a piece of writing like this, it's actually a great way to highlight the core point of the article, as well as one of the key values of the bitcoin and cryptocurrency movement (more on that later).
Trust carries risk.
In finance, as in life, trust is unavoidable in some measure. But when your hard-earned money is on the line, blind trust can rob you of returns and your future financial security.
For example, when you buy shares in a company, you're trusting that company's CEO, board and employees in their vision, integrity and abilities. The history of business collapses, from the South Sea Company in 1720 to Lehman's in 2008, shows that trust can easily be misplaced. And it's often impossible to know who you can't trust until it's already too late.
If there's one message to take away from this article, it's precisely that: Don't put all your eggs in one basket. Don't trust one source of information or advice (including this one), don't entrust one single company or bank or pension fund with your financial wellbeing, don't even trust one asset class.
Diversify. Spread risk. And do your own research as well as seeking advice from experts.
With that overarching principle in mind, what might that look like in practice?
Risk, Return, Timescale, Tax
For any investment, there's generally a link between risk and return. The higher the potential returns on an investment, the more risk and volatility there is. Take the stock market, which has (historically) proven a good investment, returning maybe 8-10% annually over the long term. Over the short term, however, the value of the market as a whole, let alone individual stocks, can go up and down dramatically.
Imagine you invested your life savings of $100,000 in the S&P500 – an index of the 500 largest companies in the US – in February 2020. A month later, your net worth would have dropped by a gut-wrenching third to $70,000. Hold on for another year and not only has it recovered, but you're up 20% at $120,000. It's a rollercoaster. It's only on the scale of many years or even decades that the
ups-and-downs are smoothed out and the price chart clearly progresses from the bottom left to the top right of the chart. That's why most financial advisers recommend only investing in stocks if you can hold them for at least five years and ideally 10 or more.
Then, of course, there's the risk of an asset simply collapsing entirely. In the early years of the cryptocurrency movement, there was no guarantee that bitcoin and the new technologies it represented would survive – let alone spawn the $2 trillion asset class that crypto is today. Early adopters, who believed in the idea of digital money that avoided points of trust like banks and payment processors, took the risk that they would lose everything. Those who held firm saw their investment grow from a few cents or a few dollars per coin to tens of thousands of dollars today. The outsized returns corresponded to the outsized risks they took.
Diversification means spreading risk across several different investments, so that if any one of them underperforms or fails entirely, it won't destroy your whole net worth. Conversely, that gives you room to include investments that have the potential to outperform and bring outsized returns. Yes, if you go all-in on a promising investment, you could make millions. Equally, though, you could lose it all.