Six Investment and Risk-Taking Lessons to Learn from The Crypto Crisis

It was in mid-2017 when I first heard about Bitcoin and cryptocurrency. The crypto markets were on a massive bull run, and it was around the time cryptocurrency started going mainstream. The same year, a friend conned me Ksh30,000 under the guise of helping me invest in forex trading.

Had I put the Ksh30,000 into Bitcoin in May 2017, the Ksh30,000 would now be worth Ksh395,000. At Bitcoin’s peak in November last year, the Ksh30,000 would have been worth over Ksh600,000. All passive income.

After tanking in early 2018, the crypto markets got into another extended bull run. People who’d put their money into crypto started becoming overnight millionaires. Everybody wanted in.  

As the markets approached their peak last year, greed kicked in. Everyone and their mom started putting their money into cryptocurrencies hoping to make a quick buck.

After the peak last year, the crypto market has since been on a downward trend, which culminated in a massive crash last week. People lost billions, with some even losing all their life savings.

I’m a believer in the saying that every cloud has a silver lining. Even as the market reels from the recent crash, I believe that there are lessons we can learn from it. Below are six things that the recent crypto crisis teaches us about investing and risk-taking.

1. Know Your Risk Tolerance Levels

Every investment carries some degree of risk. However, some investments, such as cryptocurrency, carry a higher level of risk than others. Your entire investment could get wiped out in a couple of hours, as happened recently.

Before investing in an asset class, you need to think about your risk tolerance level. This is your ability and willingness to handle a loss in your investment decisions. There are three types of risk tolerance:

• Aggressive risk tolerance: Investors with high-risk tolerance are willing to lose huge portions of their investment in pursuit of maximum profits. If you have aggressive risk tolerance, you’ll favour highly volatile asset classes, such as cryptocurrencies, options contracts, and individual stocks. Such asset classes can easily make you lots of money, but they can equally wipe out your entire investment within a short time.
• Moderate risk tolerance: People with moderate risk tolerance are willing to take some risk in the pursuit of decent profits, but they are still careful about losing significant portions of their income. If you have moderate risk tolerance, you should consider investing in assets like stock index funds and mutual funds.
• Conservative risk tolerance: For these investors, their primary goal is the conservation of their principal investment. They invest in asset classes with the least amount of volatility and are comfortable with minimal profits. Examples of asset classes that tend to work well for conservative investors include fixed deposits and government bonds.

2. Invest What You Can Afford to Lose

We’ve already seen that there’s a level of risk in all investments. There’s always the possibility that you could lose your entire investment.

For instance, investors who had their money in LUNA lost over 99% of their investments in less than a month. Some lost their entire life savings, while others are at risk of being left homeless because they invested borrowed money.

To avoid ever finding yourself in such a situation, it’s not advisable to invest all your savings, especially when investing in a volatile asset. Before investing, think about what would happen if you lost your entire investment.

If losing the money will leave you unable to survive or wipe off everything you’ve worked for your entire life, it’s not wise to put all that money in the same investment. Instead, you should only invest amounts that you can afford to lose. This way, even if the investment goes awry, you’ll still be fine.

3. Invest for The Long Term

One of the biggest mistakes people make is investing with a short-term view. If you’re investing in an asset class with the aim of selling and profiting within a few months, there’s a high chance you’ll end up losing your money. This is because market values fluctuate wildly over the short term.

For instance, if you look at the price of Bitcoin over the last year, you’ll notice huge fluctuations. In the span of 12 months, the price of one Bitcoin started at around the $42,800 (Ksh ) mark in May 2021, dropped to about $29,000 (Ksh ) in July 2021, rose to an all-time high of over $68,000 in November, and is now hovering around the $29,000 (Ksh ) mark.

Source: CoinMarketCap

If you invested in Bitcoin somewhere within this timeframe with the aim of selling within a few months, you could have either made money or lost money. It goes both ways because of the market fluctuations.

However, anyone who invested in Bitcoin over 5 years ago and held their investment till date has seen their investment grow in value, despite the fluctuations in between. 

Source: CoinMarketCap

Generally, most asset classes tend to perform well over the long term, despite wild swings experienced over the short term. Therefore, in my view, if you want to minimise your risk and realise gains from your investments, it’s a good idea to invest with a long-term view, typically three years or more.

Aside from increasing your likelihood of growing your investments, investing with a long-term view also shields you from the emotions caused by short-term swings. Even if a stock or security falls in value after a few months, you’ll not really be stressed because you’re not chasing after short-term profits. You know that eventually, there’s a good chance that it will turn around.

4. Start Investing Early

One of the most important things to do when it comes to investments is to start investing as early as possible. Investing early allows you to catch the wave as it is starting out. The longer you wait, the more likely you are to get in near the crest, where there’s little money to be made.

For instance, those who invested in cryptocurrency in 2013 have made way more money than those who invested in 2017. Similarly, those who invested in 2017 have made way more money than those who invested last year.

Besides getting in while the value is still low, investing early also allows you to maximise the power of compounding.

To understand how this works, let’s look at two people, James and Peter, who invest Ksh10,000 into a money market fund with an average annual return of 8%. James starts investing at age 25 till retirement at 65 years, while Peter starts at 35 and continues investing till retirement.

By the time they retire, James' investments are going to be worth Ksh31 million, while Peter’s investments will be worth about Ksh13.5 million. Even though James contributed just Ksh1.2 million more than Peter (Ksh10,000 x 12 x 10), he’ll end up with Ksh17.5 million more than Peter at retirement simply because he started earlier, giving his investments more time to gain compound interest.

The longer you wait to start investing, the harder it becomes for you to catch up with those who started earlier.

5. Diversify Your Investments

Investors who had their money in TerraUSD lost over 90% of their investments in the last 30 days. In the same period when most cryptocurrencies were falling, those who had their money in TRON saw the value of their investments grow by over 16%.

If you had invested Ksh100,000 in TerraUSD 30 days ago, your investment would be worth less than Ksh10,000 today. However, if you’d invested Ksh50,000 in TerraUSD and Ksh50,000 in TRON, your investment would be worth Ksh63,000.

The point here is that, when investing, it is possible to reduce the impact of market fluctuations and limit your losses by diversifying your investments. This is the classic case of not putting all your eggs in one basket.

Investing in an individual stock, cryptocurrency, or security bears a huge risk. To limit your exposure, it makes more sense to diversify your investments into a mix of assets.

An even better approach is to put your investments in different asset classes. For instance, you could put 30% of your investments in real estate, 20% in stocks, another 20% in government bonds, 15% in commodities, and another 15% in alternative investments.

With such a portfolio, it’s very unlikely for your entire investment to get wiped out because these different asset classes don’t respond the same way to market conditions.

6. Do Your Due Diligence

Over the last two or three years, a lot of people invested their money into cryptocurrencies without a good understanding of what they were getting into. They only did so because they heard stories of people getting rich with cryptocurrency.

When prices started falling, these people panicked and started selling because they didn’t understand what drives the value of the coins they invested in - in my opinion. 

Here’s the thing. If you want to make money, don’t invest in something you don’t understand. This doesn’t just apply to cryptocurrencies but to all investments.

For instance, don’t buy a stock just because your friends believe it’s the next hot thing or because its prices are rising at the moment. Instead, you should do your due diligence, understand the fundamentals behind the stock, and only invest if you believe in the future profitability of the company.

WRAPPING UP

Investing is a great way to grow your money and secure your future, but it needs lots of caution. Otherwise, you could easily end up losing all your money. 

I hope that after reading this article, you’ve learnt some useful tips that will help you make better investment decisions and minimise the risk of losing your money.

Here’s a recap of the six tips:

1. Know your risk tolerance levels
2. Invest what you can afford to lose
3. Invest for the long term
4. Start investing early
5. Diversify your investments
6. Do your due diligence

DISCLAIMER: Money254 is not an investment advisor and does not provide investment advice. The articles we publish are for awareness and educational purposes only.