One of the most common cries you hear when it comes to investment is that you need to diversify. Putting all of your eggs into one basket is a foolish move, which is the reason for the prolific investment of retirement funds into mutual funds and index funds that are fairly stable. Even the pros invest in everything from futures to currency and real estate, spreading their risk over a wide variety of markets.
The investment landscape is changing in the digital age though. Apps like Robinhood and E-Trade have spawned investments by the everyman, armed with crowdsourced knowledge and online recommendations. The cryptocurrency market has also changed the investment landscape as well, with millenials investing heavily in this volatile and high-risk market.
Housing and real estate have also recovered, and investing in them is much more difficult in urban areas, where many feel that property is potentially overvalued and prices are high. So what is the right diversification strategy in a digital age? Here are a few aspects to consider:
The Day Trader and E-Trade Phenomena
There are two types of traders: those who make money and those who don’t. First, it is a good idea to understand what day trading is and what E-Trade and Robinhood are really for. Understanding this makes understanding its effect on the market much easier.
Day trading is by definition buying and selling stocks in a single day. Ideally at the end of any day, a trader will have no open positions so that if the market turns overnight when they are not trading, they will not lose money. E-Trade and Robinhood, along with similar apps, allow traders to invest without going through a traditional broker or professional coach. Trades can be done quickly and often are completed on a mobile device. Advice is available from professionals on either blogs or through other tools on the app, but the user must understand how to use them.
The most successful day traders invest large sums of money in stocks that will experience small gains in a single day. This is one of the reasons most individual traders lose money. They do not have enough to invest, and small gains may not even cover the transaction fees they were charged. Day trading is much like high-stakes gambling. It is as much about reading the market and people than anything else, and takes more than just market knowledge to be successful. It takes good instincts and a willingness to lose just as often as you win.
The average investor cannot afford this, and the trend is to follow the crowd. The issue with that is by the time a lot of people have invested, the investment is likely about to top out. This is simply the way the market works, so the majority who did not jump in on the investment early lose money, and those who jumped in near the top and even sell at the right time experience only small gains.
However, it is these people who drive the market. When everyone is buying, the tendency of many is to buy, and when the majority is selling, people tend to do the same. This means that only the few who don’t follow the trend and time their buying and selling correctly make money, and according to Vantage Point Trading, 95 percent of traders lose money, and only 1 percent make real money.
Therefore it is important to understand that investments should be a long-term strategy, and investment in stable stocks or diversified funds is still the best strategy even in a digital age. Consulting a financial analyst is the best way to make sure you are following a smart investment strategy even if you do your own trading and only check in with them from time to time. The role of the financial analyst is changing due to technology, but it is not going away.
Crypto, the Blockchain, and Risk
When talking about investments, often we hear the term “risk capital.” What does it mean? Essentially this means money that you have on hand but can afford to lose. Cryptocoins remain volatile and high risk, but they are gaining ground as mainstream investments. So why invest in them and include them in your diversification strategy? Because in some cases high risk is both appropriate and worthwhile.
The other aspect of cryptocurrencies that is having an effect on investments is the blockchain. While many coins remain in the fringes of investment, the idea of the blockchain when it comes to security has many investors and others intrigued. The reason is that the blockchain acts as a distributed ledger housed on the computers of those involved in a transaction.Once a block on the chain is created, it cannot be altered. This is a potential way to prevent devastating hacks and other software glitches that could affect markets negatively. As the threat of cyberattacks increases, the search for better security solutions continues, and the blockchain is only a part of that picture.
Despite the risk of cryptocurrency, several investment companies are embracing them. Deloitte offers clients initial coin offering (ICO) services and solutions, and Ernst and Young even accept bitcoin in payment for their services. Pricewaterhouse Coopers has even spearheaded an effort for digital assets to be accepted for everyday purchases with some success. Blockchain initiatives are now common with many leading investment companies.
WIth the rise of cryptocurrency, this offers an additional high-risk investment for day traders and others working with risk capital, and in some cases takes investors away from other investments that are also high risk. This has an effect on commodity and other currency exchanges, and offers yet another diversification avenue.
Wealth, Retirement, and the Thrill
Whenever an individual sits down with a financial advisor, a professional will ask them a series of questions, and these are the same questions the investor should be asking themselves when developing a diversification strategy. Here are a few of them, with some answers:
Why are you investing? Many people are investing to build wealth and security. Others are investing for retirement, and some like the thrill of the hunt for the perfect stock or the big win. The latter is akin to gambling in many ways while the other two are a search for future security.
How much money do you have to invest? Larger investments usually mean lower fees and commissions (if any), and that makes it simpler for small gains to cover them. Smaller investments will take more time to mature and break even. This does not mean that smaller investments are not worthwhile; it simply means that the less you can invest, the longer you will need to wait for significant return.
How much time do you have to invest? This relates to retirement and wealth building primarily. If you are aiming for early retirement, how many working years do you realistically have? For instance, diversifying investments is much different at 20 than the diversification and investment strategy for an investor who is 50 or older.
When you can adequately address the why behind your investments and the return you are looking for, you can better inform your diversification strategy. This strategy will be different in a digital age, and may mean online investing, day trading, or even the high risk of cryptocurrency. The one thing that is certain is that the underlying principles of investment still apply, and following the fickle whims of the market will always be a gamble. Diversifying minimizes that risk and ensures overall you are much more likely to come out ahead.