A workmate is involve in all this cryptocoins investments and everyday share with the rest of us some articles and videos… to illuminate us about tendencies, but to be honest I haven’t enough time to read all the stuff that he shares with us so I have to make a vertical read to analyse roughly some information and I want to share something that I think that could be useful if you are thinking in any kind of investement. I don’t know his source but this is the text:
After having some real nice profits and losing most of them during this dip ( due to fear of selling, buying again etc) i now realize the importance of profit taking.. In stock investment is actually real simple, 4% is “the golden rule” obviously this doesn’t apply to crypto. Do you have a plan for this?*
Some very smart people at Bell Labs figured this problem out decades ago. They were trying to understand how much money to bet on horse races. The solution is called the Kelly Criterion.
Basically for any investment, bet or gamble, the optimal amount of money to utilize is [Edge]/[Odds]*[Wealth]. The idea here is that if you keep betting the farm, eventually you will lose the farm. The only time it makes sense to bet everything is if it’s 100% sure shot. Even if you have an advantage, the more uncertainty the less of your total wealth you should bet.
Specific to Bitcoin, if the future is anything like the past it has very high expected future returns. However it also has extremely volatility compared to other financial assets. It makes sense to invest in, but it definitely doesn’t make sense to invest all or even most of your personal wealth in.
That’s where the other insight of the Kelly Criterion comes in. You should be scaling your bets to the total size of your bankroll or personal wealth. This gets to the problem you’re describing. If you bought bitcoin years ago, you probably made an investment that was only a small percentage of your overall wealth. However because bitcoin has returned so much, that investment now represents a substantial portion of your total net worth.
To take an extreme example let’s say you bought $1000 worth of bitcoin in 2011 at $1/BTC. Maybe you had $10,000 in the bank at the time. You made a sensible decision to invest 10% of your wealth in bitcoin. If you’ve been holding all this time, you now have $14 million worth, and 99.99% of your wealth is BTC. It’s not sensible or prudent to have that much of your wealth in a single asset.
If you go back to your original allocation, you should rebalance to keeping only 10% of your wealth in Bitcoin. That means selling all but $1.4 million worth, and investing the rest in another asset. Or maybe something different, to reflect that BTC in 2017 has a different risk/return profile than BTC in 2011. But regardless of whether your $14 million in wealth came from an early crypto investment, or a random inheritance, the optimal financial decision is not any different.
Pick a certain percentage of your total net worth that you want to keep invested in bitcoin. Whether bitcoin goes up or down, that number should not change unless there’s a meaningful change to bitcoin’s future outlook. Then with at some regular interval, rebalance your portfolio to keep your bitcoin holdings in line with that percentage. E.g. if you decide that number is 50% and you start out with 25k in BTC and 25k in USD, and BTC goes up 20%, then you sell $2500 of BTC. If BTC went down 40%, then you’d buy $5k worth.
“Perfection is attained not when there is nothing more to add, but when there is nothing left to remove”
— Antoine de Saint Exupéry