Why your investment portfolio needs reasonable allocation and diversification.

Introduction: Risks Always Exist, But They Can Be Managed

In the world of investment, risks are always present. Putting money in the bank will slowly erode your purchasing power due to inflation; investing in the stock market may lead to losses. But this does not mean you are powerless— the key lies in how to adjust and respond to these risks based on your investment goals.

The reasonable allocation of assets and investment diversification are two core tools to address this challenge. Although these concepts sound modern, their origins date back thousands of years. This article will take you deep into the essence of these two concepts and how they are applied in contemporary investment management.

Allocation and Diversification: Don't Put All Your Eggs in One Basket

Many investors often confuse the concepts of “asset allocation” and “investment diversification”. Although they are closely related, they focus on different aspects.

Asset allocation refers to how you distribute your capital among different asset classes such as stocks, bonds, cash, etc. For example, you might decide to invest 40% in stocks, allocate 30% to bonds, venture 20% into crypto assets, and keep the remaining 10% in cash.

Investment diversification focuses on the allocation within these major categories. Taking cryptocurrency assets as an example, you might choose to allocate 70% to Bitcoin, 15% to mainstream coins, 10% to mid-cap projects, and 5% to small-cap coins.

The ultimate goal of these two strategies is consistent: to maximize expected returns while minimizing risk. The key to achieving this goal is to select assets that have low correlation, or even negative correlation. When one class of assets performs poorly, other assets may perform well, thereby offsetting potential losses. In short, a reasonable allocation and effective diversification can make your investment portfolio more resilient in the face of challenges.

Modern Portfolio Theory: Explaining Investment Philosophy with Mathematics

In 1952, economist Harry Markowitz published a far-reaching paper that laid the foundation for Modern Portfolio Theory (MPT). This theory later earned him the Nobel Prize in Economics.

The core insight of MPT is that different asset classes perform differently under various market conditions. When one asset class is underperforming, another may be on the rise. Therefore, by combining assets with low correlation to each other, it is possible to reduce overall portfolio volatility while enhancing risk-adjusted returns.

In other words, if two portfolios offer the same return, a rational investor will always choose the one with lower risk. MPT tells us that the most efficient approach is to select assets that are not perfectly correlated for allocation.

Practical Application of Two Major Configuration Strategies

In practice, investors typically choose two main asset allocation methods:

Strategic Allocation: This approach is more conservative and passive, suitable for long-term investors. The allocation ratio is generally only adjusted when the investor's risk tolerance or time planning changes.

Tactical Allocation: This approach is more flexible, allowing investors to adjust their allocations in a timely manner based on market performance. If a particular sector performs exceptionally well, investors can increase the allocation percentage for that sector, potentially leading to better returns. Although this method also follows the diversification principle of MPT, it gives investors more control.

It is important to note that assets do not need to be completely unrelated to benefit from diversification— as long as they do not move in complete unison, they can have a positive effect.

From Theory to Practice: A Specific Configuration Case

Imagine an investor deciding to allocate their investment portfolio according to the following ratios:

• Stocks: 40%
• Bonds: 30%
• Crypto Assets: 20%
• Cash: 10%

In the allocation of 20% to crypto assets, a further diversification strategy could be as follows:

• Bitcoin: 70%
• Mainstream Crypto Assets: 15%
• Mid-cap projects: 10%
• Small market cap projects: 5%

Once these allocation ratios are determined, they need to be monitored regularly and adjusted based on actual performance. When the price of certain assets rises, causing their proportion in the overall allocation to exceed the target, investors should consider “rebalancing”—selling well-performing assets and buying underperforming assets to restore the predetermined allocation ratio.

The configuration scheme in this example carries relatively high risks, as a significant portion is allocated to a highly volatile asset class like cryptocurrencies. Investors with a higher risk aversion may choose to increase the allocation to bonds, which would significantly reduce the overall risk level of the investment portfolio.

Unique Challenges in Cryptocurrency Asset Allocation

Although the theory of asset allocation and diversification should generally apply, the practical situation in the cryptocurrency market is much more complex.

The cryptocurrency market faces a real issue: the prices of most assets in the market are highly correlated with the price movements of Bitcoin. This makes it difficult to establish true diversification within crypto assets—how can you pick uncorrelated assets from a class of assets that are highly correlated internally?

At times, some altcoins may exhibit different trends compared to Bitcoin, and savvy traders can take advantage of these opportunities. However, such situations often lack consistency and predictability, unlike traditional financial markets where systematic strategies can be applied.

However, in the long run, as the cryptocurrency market matures and develops, we can expect to achieve more systematic and effective diversification strategies in cryptocurrency asset allocation. However, at this stage, the market is still quite far from this ideal state.

Practical Difficulties of Asset Allocation Strategies

Although asset allocation and diversification are theoretically very powerful, challenges often arise during implementation.

First, creating a configuration plan is relatively easy, but the real test lies in execution. Many investors find it difficult to overcome their biases, which can undermine the efficiency of their portfolios.

Secondly, the pre-assessment of investors' risk tolerance is not always accurate. As investment results gradually emerge, investors may find that the actual risk they can bear is much less (or more) than initially expected, which may necessitate adjustments to their allocation strategy.

These practical factors remind us that a perfect theory requires flexible implementation.

Summary

The reasonable allocation of assets and investment diversification are core concepts of risk management, with philosophical foundations that have been passed down for thousands of years. In modern investment management, these two strategies have become key to enhancing portfolio efficiency. By allocating capital across different asset classes, investors can not only diversify risk but also reduce volatility while maintaining target returns.

However, due to the high correlation of the cryptocurrency asset market with Bitcoin, it is necessary to exercise extra caution when applying these principles in cryptocurrency asset allocation. As the market matures, more flexible and systematic allocation methods will eventually become possible, but current investors must remain rational and alert when allocating cryptocurrency assets.