In this article we break down the concept of investment concentration vs diversification, what is best to do when trying to build or preserve your wealth, and how to get started.

The crypto industry is known to be full of risk-averse and passionate investors who have a genuine belief in the future of Bitcoin. In their eyes, we are lucky to be among the few early adopters. According traditional investors, however, we are reckless and nuts. Don’t take our word for it; Just watch Shark Tank legend Kevin O’Leary speak his mind:

Traditional investment books and courses all preach the same thing: “Don’t put all your eggs in one basket”. Diversification is one of the best strategies to hedge against risk, and one that is practised by most investors today. It is a great way to protect the value of your portfolio against uncertainty. But is it the best way to build massive amounts of wealth? Some would argue that it’s not.

This is exactly why we wrote this article. In the following chapters we will help you understand the difference between concentration and diversification, who it’s for, and what you can hope to achieve.

Concentration vs Diversification – Risk vs Reward

To understand how wealth is created, we need to explore how highly successful investors went about it. Most of them, if not all, had to take difficult decisions tied with a lot of risk. All, however, had an unshaken, intuitive belief that their decisions were in their best interest.

Peter Thiel’s $500.000 angel investment in Facebook could be seen as reckless to most, since the investor entered at a time when the social media giant was still unknown. It gets even more mind-boggling when one realizes that the average angel investment is ±$25.000.

However, Peter, who had met Mark Zuckenberg earlier, saw the potential and believed in the future of Facebook. His large investment would today translate into $9 Billion given the current valuation of Facebook.

As you can tell, intuition is important, but so is the understanding of underlying fundamentals, market trends, and economic tendencies. Without understanding what you are getting into, investing is nothing more than gambling.

So where does the concept of asset concentration vs diversification come in?

Investment concentration

Investment concentration is the decision to place your full attention and focus on a single asset. It is a very risky move, especially for those without industry-related expertise, and is often seen as an all-or-nothing bet. However, with high risk come high rewards.

Much like Peter Thiel’s investment in Facebook, a small investment in Bitcoin just a few years ago could have made you a multimillionaire today. The same is true for many cryptocurrencies but also stock options that operate in rapidly growing industries, like Electric vehicles.

Take a look at NIO for example. The Chinese EV giant was relatively unknown just a year ago, with its stock ranging between $2-$3. Today, the stock’s price is valued at $50+ and is expected to triple within 2021.

concentration vs diversification

While there may be a larger amount of risk, focusing all your attention (and funds) on a single investment option can produce massive amounts of wealth. It is a great investment strategy for those with lower capital availability, given they perform thorough research and have low-time preference.

Wealth building strategies through concentrated investing

To get started, choose one industry that interests you and start researching its trends and developments. Sooner or later you will realize where the industry is headed (at least vaguely) and you’ll be able to explore the different types of technologies that could help it get there.

Bitcoin, for example, is an exciting technology for the future of fintech, since it allows people to perform transactions in a fully decentralized manner. While the UI is still a limiting factor for the general public, it is clear that the technology will increase in demand in the future.

Once you understand the potential, you’ll need to make a decision. Will you be able to focus all your available capital on a single investment and let it grow in its own accord? Before you hastily answer yes, take a good look at your personality – are you able to control your emotions? Will you maintain a level-headed approach in case the market temporarily goes sideways?

When you make the decision and invest the amount you have available, it is important that you identify clear goals. Those will guide you along your investment journey. Here are some useful questions to ask: What do you want to get out of this? What is the exact amount at which you plan to sell?

Investment diversification

They say that making money is relatively easy; protecting it is where the real challenge lies. Diversification is the process of spreading your capital over many different assets in order to minimize the risk and increase your chances for stable portfolio growth. This is a great strategy to follow when considering how to protect your assets and wealth in the long run.

Let’s momentarily assume that you invested $1000 in Bitcoin back in 2010-2011 and are now significantly wealthier. You have not used your Bitcoin for all this time and you now find yourself with a large amount of money. Due to the volatility of Bitcoin, however, you feel uncertain, and want to diversify your holdings in order to protect them from a potential crash in Bitcoin’s price.

In this case, you might want to take 80% of your Bitcoin and allocate it to:

  • 20% – Cash or FIAT-backed stablecoins
  • 10% – Gold or gold-backed stablecoins
  • 10% – Popular altcoins (ETH, LTC, and more)
  • 10% – NFTs or other types of collectibles (digital art, trading cards, etc.)
  • 10% – Real estate (rental properties, office space, or even parking spaces)
  • 20% – Low-risk stocks (spread among several stocks, eg. FANG stocks)

Having many different types of assets ensures that you will not lose everything in case on particular investment does not work out as intended. For example, if the NFT market ends up saturated and your investments have no liquidity or demand, you will only lose 10% of the value of your portfolio. The remaining 90% will remain intact and even grow in the meantime.

Wealth preservation strategies – Choosing the right split

The above example is only one of the many you can follow when it comes to asset diversification. The exact split you decide to go with will depend on:

  • Your experience and expertise with an industry
  • The size of your capital (e.g. You can’t purchase real estate with $1000)
  • Your goals (what is the % APY you wish to generate?)

Overall, your wealth preservation strategy should help you:

  1. Avoid inflation against FIAT currencies
  2. Avoid the risks associated with unstable investment options
  3. Grow the value of your portfolio in a stable way

You can explore multiple portfolio setups to understand how a person deals with risk, and how much they actually believe in their investment.

So what is best for investors – Concentration or Diversification?

Concentration vs diversification can be observed in most of the things we do in real life. If we wish to achieve a certain goal, we need to focus all our attention to it.

For example, an overweight person will need to prioritize fitness and a healthy diet for a sustained period of time until the goal is reached (concentration).

Once the goal physique is reached, gaining back all the weight is very easy. Therefore, the person will need to formulate and practice a certain set of habits on a daily basis to ensure that the weight remains off (diversification).

  • In the concentration phase, the person was purely focused on one thing -> Losing weight.
  • In the diversification phase, the person diversifies attention into a set of habits that lead to -> Maintaining a healthy physique.

The same thing applies to investing. When a person starts from zero, building wealth is more likely to occur by focusing one’s attention on one specific asset for an extended period of time. Others’ opinions and beliefs are irrelevant, as you are more experienced in the industry and believe that the potential is there.

Once wealth is acquired, diversification will help the person protect it in the long run. This is done by creating failsafes through the diverse allocation (if one fails, the rest survive). You can only protect something after you have successfully earned it.

Asset Allocation vs Diversification

The two terms are often interrelated, but what is their difference? As aforementioned, diversification is the process of spreading your funds among many different investment opportunities.

This “spread” is also known as asset allocation. For example, you could say that: “I have diversified my asset allocation in 10 different investment options”. In essence, you take a position in several assets.

What is strategic asset allocation?

Strategic asset allocation refers to a diversification plan that is executed in a longer period of time, during which the assets are not exchanged or sold for other options. In the context of cryptocurrency, strategic allocation is equivalent to HODL for longer periods of time.

What is tactical asset allocation?

Tactics are short-term actions that are taken in hopes of achieving a (sub)goal. In this case, the investor may attempt to profit from certain events or trends, by taking a position for a smaller amount of time. For example, when Bitcoin crashed to $4000 in March 2020, many investors performed a tactical asset allocation in BTC to benefit from its subsequent recovery. In the context of cryptocurrency, tactical allocation is equivalent to sentiment trading.

Bringing it back to the world of crypto

The next few months are going the be very interesting for the crypto industry. As the world is starting to take notice of Bitcoin’s potential, an unprecedented opportunity presents itself – that of taking a concentrated bet on BTC. For many, this bet offers an asymmetric risk/reward ratio that will cause a massive shift of wealth. Therefore, if you are still thinking about Bitcoin, it might be time to act.

For those who acted long ago or enter the market with significant capital, the large availability of cryptocurrencies is a great way to diversify. While it’s best to allocate the majority of your funds towards popular cryptocurrencies with proven utility (BTC, ETH, BNB), you can research many small-cap coins with strong fundamentals.

Conclusion

You should now have a better idea with regards to portfolio concentration vs diversification. This article explored the reasons behind taking riskier singular bets and why these are great for new investors. It also delved into the reasons behind multi-asset diversification, and how it’s best for wealthy individuals who wish to protect the value of their portfolio.

Overall, it is important to understand that both concentration and diversification are necessary strategies in the world of investing. Especially for markets that are still undergoing their price discovery phase, like cryptocurrencies, knowing when to go “all in” and when to build a balanced portfolio will help you maximize your profit potential.

Keep in mind that all the information found in this article does not constitute financial advice and is only meant to serve as an educational resource.