Investment opportunities come with risks. That is the unchanging reality in the financial world. With the boom of cryptocurrencies, many new investors assume that the investment risk levels in crypto are similar to mainstream stock markets. It is critical to stress, however, that that is not the case.
The crypto space is marked by high volatility and massive price swings that dip and rise in the span of a few hours. Expectedly, not everyone is equally comfortable with the risks attached to that. Hence, before you even think of investing in altcoins or getting an XMR wallet, you need to have a clear understanding of your risk tolerance first.
To elaborate further, here is a quick rundown of what risk tolerance is, its role in investing, and why understanding your risk tolerance is especially crucial in the realm of cryptocurrency.
Why Is Risk Tolerance Important?
Risk tolerance refers to the measure of how much an investor is willing to lose in any given expenditure. It is also defined as the degree of risk that you as the investor would be comfortable enduring within your portfolio. It is often classified into three degrees:
- Aggressive risk tolerance – The higher the risk, the higher the return. This is the mindset that investors in this tier abide by. They often invest in highly volatile assets with the aim of reaching maximum returns despite the high risk of losses.
- Moderate risk tolerance – In this tier, investors divide their portfolio into two general parts: high-risk and low-risk investments. The aim is to strike a balance between the two and explore investment opportunities with relatively lower risk.
- Conservative risk tolerance – As its name implies, investors with conservative risk tolerance tend to back low-risk assets of good repute. These assets comprise companies and institutions who have already, more or less, proven themselves. As a result, their stock values are stable and often steadily increase over time. When you invest in them, you are sure to profit although not by much nor too quickly.
Risk tolerance is an important part of portfolio risk management because it helps you determine your investment strategies and choose which assets to support. Without understanding it, you increase the likelihood of committing potentially expensive mistakes. For example, wrongly assuming that you have an aggressive risk tolerance may push you to invest in highly volatile assets. When their prices dip, you may end up becoming afraid of losing your investment, panic and then sell your stocks too quickly. As a result, you incur losses when prices rise again.
When you consider the extreme volatility of cryptocurrency markets, the need to have a clear understanding of your risk tolerance when it becomes exponentially greater. You have to be realistic on how much variability you are willing to withstand. And to accomplish that, you have to inform yourself of the risks involved in the crypto market first.
Understanding the Risks in the Crypto Market
Your risk tolerance is an effective way to discern whether investing in crypto is the right move for you or not. However, you need to stop looking at the crypto market with rose-colored lenses. Before stepping into the crypto market, you need a clear picture of the associated risks. Aside from price volatility, some of the other concerns you should consider include:
- Hacking and digital theft – Considering that the money in crypto is fully digital, you always run the risk of losing them due to hacking and other types of online theft.
- Unfavorable government regulations – Crypto has received pushback from various governments, with some countries banning it completely (e.g. China).
- Possible loss of access – If you lose the private key to your wallet, you lose access to your coins. While they may not get stolen, you lose the ability to transact with them.
- Influence from whale activities – Whales refer to individuals or groups with a significantly large cryptocurrency holding–so significant that they influence market prices based on their activities alone. As a result, your investment’s performance is heavily reliant on how they move rather than the asset’s potential alone.
Considering all of these concerns, it is time to ask yourself: how tolerable are these risks to you as an investor?
Assessing Your Risk Tolerance
There are plenty of tests you can take to assess your risk tolerance. No matter what the result is, however, the final decision of acquiring a crypto asset rest on you. Ask yourself: How does crypto fit into my investment strategy? Will it bring me closer or farther from my financial goals?
If it does help you, use your risk tolerance as a guide. Different coins have varying levels of volatility. With the wide selection of digital coins available, you will never run out of potential assets to invest in.
Overall, understanding your risk tolerance is a crucial part of being a good investor. As you enter the crypto market, don’t forget to always take it into consideration.