Psychology and risk management in crypto: how overinvested are you really?

In the world of crypto, many have hopes to make big profits. The rise of Bitcoin, Ethereum, and other digital assets has led to people investing their hard-earned money, often without fully considering the implications. I once was overinvested by A LOT (insert Hard Rock Nick meme here) and it was too late for me to realize this…

When I finally learned the hard way, and did not invest more than I could afford to lose, I had a huge peace of mind and the volatile price action of the crypto market didn’t have any (emotional) effect on me.

I want to explore the topic/question of, and hear your thoughts about, what it means to be overinvested in crypto, where to draw the line between being overinvested and not, and the psychology of investing.

Finding peace of mind

One of the rules of investing is to never put in more than you can afford to lose. This solid advice holds particularly true in the highly volatile world of crypto. Overinvesting in crypto can lead to financial stress, anxiety, and sleepless nights, as you constantly fret over price fluctuations.

According to a study published in the Journal of Behavioral and Experimental Finance, "Individuals who overinvested in cryptocurrency displayed a higher level of financial anxiety and poorer psychological well-being compared to those who had diversified their portfolios."

The study further noted, "The emotional toll of being overinvested in crypto was evident, as participants reported higher stress levels when the market was turbulent."

Source: https://www.sciencedirect.com/science/article/pii/S2214635022000181

Emotional resilience in a volatile market

The emotional rollercoaster of crypto can be overwhelming. Those who have invested more than they can afford to lose, may find themselves making impulsive decisions based on emotions rather than rational analysis.

A study by the Journal of Economic Behavior & Organization suggests, "Investors who are not overinvested in cryptocurrencies tend to exhibit better emotional resilience during price volatility. They are less prone to panic selling during market downturns and less likely to chase short-term gains."

By avoiding overinvestment, you can better weather the storms of the crypto market. This way you have a better position in your long-term investment strategy.

The speculative nature of crypto

While I believe in the potential and future of cryptocurrency, it is crucial to remember that it remains a speculative asset. Bitcoin (and especially other alts) have yet to achieve the stability and maturity of traditional financial assets.

Understanding the speculative nature of crypto is essential, as it underscores the importance of not overcommitting your financial resources to this volatile market. Even if you “believe” in the tech or the fact that fiat money and financial systems (the way it is right now) is not sustainable.

The wisdom of diversification

Aside from avoiding overinvestment in crypto, diversification is a fundamental principle of investment. This strategy involves spreading your investments across different asset classes, such as stocks, real estate, gold, and of course: cryptocurrencies.

Research published in the Journal of Finance and Economics supports the wisdom of diversification. "Diversified portfolios tend to yield more stable returns over time. They also exhibit lower overall risk compared to portfolios heavily concentrated in a single asset class."

By diversifying, you not only reduce risk but also ensure that your financial well-being is less dependent on the performance of a single asset class, mitigating the stress associated with extreme market fluctuations.

TLDR:

In conclusion, the question of how overinvested you are in crypto is a vital one. For your financial as well as your emotional well-being.

I am curious what you guys/gals think about this? How do you handle this issue? Even though if you believe in crypto, do we need to create more awareness about the risks of being overinvested? And how do we achieve this?