Why Invest in Crypto: Part 1 — Correlation
A Correlation Case for the Crypto Portfolio
In this series, the Coinplan team is breaking down a few reasons why retail investors should invest in a high-quality portfolio of cryptocurrencies. I’d love your feedback — Please shoot me an email at chris@coinplan.io to continue the conversation.
“Convince me why I should invest in cryptocurrency right now?”
A question I’m sure many investors have received from their friends and colleagues over happy hour. As the co-founder of an automated crypto wealth management platform, I get that question all the time. So today I’m offering a simple answer to that question: crypto is uncorrelated to the U.S. stock market. Let me first explain a few fundamental finance concepts that prove my point:
Correlation
Correlation, in financial terms, is a measure of how one asset performs compared to another asset. Positively correlated assets move together, uncorrelated assets do not move together and negatively correlated assets move in opposite directions. Assets are “scored” for 1 to -1 (1 meaning perfectly positively correlated, 0 meaning perfectly uncorrelated and -1 meaning perfectly inversely correlated). For example, gold futures are uncorrelated to the S&P500. So if the S&P500 begins to fall into a recession, gold futures would maintain its value.
Why does correlation matter? When building a portfolio of financial assets including stocks, bonds, real estate, alternative investments and others, it is vital to invest in uncorrelated or negatively correlated assets because it lowers the risk of your overall portfolio. This means if one asset in your portfolio declines in value, the other assets will remain steady or even increase in value. This is the basis for a diversified portfolio. Here is a simple correlation chart of familiar assets:
Diversification
Diversification is simply lowering the risk of your overall portfolio by investing in uncorrelated or inversely correlated assets. We touched on this a little above, but its important to know because diversification is one of the cornerstones of sound investing. I’m sure at some point your parents told you the timeless phrase:
“Don’t put all your eggs in one basket.”
This holds true in investing. By diversifying your portfolio, you decrease the overall risk of your portfolio.
Putting it All Together
Back to crypto — in the correlation chart below from October 31, 2018 you can see that the top 13 cryptocurrencies have correlations to the S&P500 between 0.09 and -0.13.
This means the top cryptocurrencies are almost perfectly uncorrelated to the S&P500.
So what, who cares? Well, every investor should care because this means that the top cryptocurrencies are almost a perfect diversification investment for the most popular investment in the U.S. The S&P500 is comprised of the 500 largest U.S. based companies and is synonymous with “the market” in the U.S.
Conclusion
By investing in high-quality cryptocurrencies, investors can reduce the overall risk of their portfolio and even protect their portfolio from an economic downturn in the U.S. stock market.
Now, if only there was an investing platform that made it easy for retail investors to invest in a portfolio of high-quality cryptocurrencies that are automatically rebalanced and managed to mitigate volatility in the crypto market…
Thanks for reading! If you like what you read please give me a few claps so I know I’m on the right track. If you didn’t enjoy this article, shoot me an email at chris@coinplan.io so we can further the conversation.
