One of the keys to long-term success is to keep your portfolio's mix of tokens, and desired level of risk, consistent over time. This is known as ‘rebalancing’ your cryptocurrency portfolio. If you never rebalance your portfolio, you’re letting the market decide your risk level instead of controlling it yourself.
For example, Figure 1 shows how a portfolio that started out as a moderate-risk portfolio in 2017, with 50% Ethereum (ETH) and 50% Bitcoin (BTC), would have drifted to 90% ETH and 10% BTC by early 2018 if it had not been rebalanced. This means that it had become a riskier portfolio, with higher expected volatility, just before the market crash in 2018. The result would have been a bumpier ride than expected. By the time the market reached its bottom in 2018, ETH losses had caused the portfolio to drift to a 70/30 mix, with less BTC and more ETH than planned. This means that the portfolio would not be set up with the right amount of risk to take full advantage of the high returns associated with the early stages of market recovery. By the end of 2020, the portfolio would have stayed at 30% BTC and 70% ETH. And by the end of 2021, it would contain 88% ETH and only 12% BTC. Again, a high-risk portfolio containing more ETH than originally planned.
Source: Bitcoin and Ethereum price data from CoinMarketCap.
This drift may seem unproblematic as long as cryptocurrencies are rising, but everyone knows that the market doesn’t always go up. If the portfolio drifts from 50/50 to 90/10, this trader would be much more likely to lose money when the market declines. These declines can be severe and short-lived, like in Q3 2021 when the markets recovered quickly. Or they can be severe and long-lasting, like the crash of 2018. During these down periods, traders often let their emotions get the best of them. For example, some traders abandon their plans at or near the bottom and then miss the inevitable upswing. Finding the right mix of tokens based on your goals and risk tolerance - and then maintaining that mix over time - can help take the emotions out of your decision-making, giving you a less bumpy ride through the ups and downs of the market.
In the long term, rebalancing tends to reduce risk. This is because riskier tokens often increase in value and make up a larger share of the portfolio than intended. As a result, the portfolio becomes riskier and more prone to losses when markets become volatile. Periodically rebalancing back to the targeted mix helps stop the portfolio from drifting to a higher (or lower) risk level than intended.
In this example, we continue with the 50/50 Bitcoin and Ethereum portfolio over the same time period. Note that this does not represent an actual allocation by FNDZ Crypto Indexes, where each portfolio is diversified and can contain up to 10 tokens, including stablecoins.
Table 1 shows the hypothetical portfolio and the number of tokens, price per token, dollar value, and weighting of each token in the portfolio.
Table 1: Initial portfolio and targeted token weightings in Jan 2017
In Table 2, we consider how price movement would change the weighting of each token and potentially lead to a rebalancing of the portfolio.
Table 2: Portfolio weightings after token price movement in Jan 2018
All figures are rounded to the third significant figure.
As shown in Table 2, Ethereum had the biggest price move (+12,000%), causing a significant tilt of the overall value of the portfolio towards Ethereum. Bitcoin made a much smaller move (+1,250%) and therefore now accounts for only 10% of the portfolio’s overall value. This weighting would trigger a rebalance in which ETH would be sold to bring the token back to its target weighting of 50%. The proceeds would then be used to buy more BTC, bringing the weighting back to a 50/50 split. The benefits would be two-fold. First, the overall decline in the portfolio’s value would be less severe during 2018, because Bitcoin declined less than Ethereum. And second, Bitcoin made a stronger recovery during 2020 than Ethereum. The trader would therefore be better positioned to benefit from the market’s recovery.
Crypto Index FNDZ use artificial intelligence to monitor your portfolio on a weekly basis and rebalance as needed. Importantly, while portfolios are monitored weekly, rebalancing only occurs when the portfolio drifts from its intended overall mix. This typically results in lower volatility and positive returns during periods of market growth. The goal of FNDZ is to provide you with a cryptocurrency portfolio that fits your risk profile and long-term goals, and to keep those goals consistent through rebalancing. Index funds are a passive strategy that focuses on long-term growth, as opposed to short-term views that try to "beat the market" through active trading. This is one of the areas where technology shines, because it prevents common trading mistakes and lets you be more disciplined in achieving your goals.