The Risks Of Overinvesting In Unregulated Markets

The Risks Of Overinvesting In Unregulated Markets

Although the market has shifted dramatically over the past few months, unregulated assets like cryptocurrency and NFTs remain popular investments, particularly for Gen Z.

For instance, one study shows that Gen Z and Millennials make up nearly 94% of all crypto buyers, and outnumber Gen X and Boomer buyers by a wide margin.

Another story talks about how the lure of making a quick buck has always attracted young people to invest in risky assets. Gen Z is drawn to the volatility and decentralized nature of digital assets such as cryptocurrency and NFTs.

While this is exciting, there’s a risk of overinvesting in these assets.

So in this article, I’ll talk about why that is and give you some alternative approaches to consider (that still encourage you to invest in crypto and NFTs!). First, let’s dig into what I mean by overinvesting.

What Do I Mean By “Overinvesting”?

When I say ‘overinvesting,’ I mean putting a disproportionate amount of money into a specific category or type of investment versus the other types of assets in your portfolio. Assuming there are any other types, of course.

Ignoring the topic at hand to give you an example, if you put all of your money into Apple
AAPL
stock, you’d be overinvested there. Meaning, logic would tell you that putting ‘all your eggs in one basket’ is not a wise investment decision and you’re beholden to the ups and downs of one individual stock.

Even if it seems like a sound investment (i.e, a home, a particular stock, or whatever you’d feel to be “stable”) there’s still risk because you’re dependent solely upon the performance of that one investment.

So you balance your portfolio out with a handful of other stocks. I’d be okay with that, as long as the industries are diverse enough, but the point is that you’re diversifying by doing that. When you’re overinvested in one particular type of investment, your risk level goes through the roof.

What Are Unregulated Markets in Investing?

In investing, unregulated markets means there are no governing bodies to help keep things in check if and when needed. It’s like an investment class doesn’t have a government – it’s decentralized. It’s managed by its owners and participants. There are no “centrally governed” rules or protections.

Don’t get me wrong, this is part of the upside to investing in things like crypto – it’s not controlled by any governing body. But the downside to that is massive – in that there are no forms of protection if something goes wrong.

A colleague of mine recently lost about $10,000 in crypto from what he thought was a secure wallet. And who knows, maybe it was, but the fact was a hacker got into it and took everything he had.

So what do you do?

If it were a credit card or fraudulent charges on your checking account, you’d have some options. But since this was crypto and it’s unregulated, he was, as my parents used to say, “SOL” (I’ll let you figure that acronym out).

Why Is Overinvesting in Unregulated Markets So Risky?

Now let’s connect the dots. Overinvesting in anything has risks, while investing in unregulated markets has risk. So what happens when you put risk and risk together? More risk!

In all seriousness, there are several key reasons overinvesting in things like crypto and NFTs is so risky:

1. You Could Lose Your Entire Investment

This is perhaps the most obvious risk of investing in crypto or NFTs – you could simply lose all the money you put in. The value of cryptocurrencies and NFTs can be incredibly volatile, and there’s always the possibility that they could drop to zero overnight. If you’re not prepared to lose your entire investment, then you shouldn’t invest in crypto or NFTs.

I’d say for many people, this is the biggest (and most obvious) risk of investing in unregulated markets. You could end up losing every dollar you put in.

Digital, unregulated assets like crypto and NFTs have extreme price volatility – meaning the value can go up or down (or even to zero) at a moment’s notice. What’s even scarier is that the majority of these assets have no inherent value (which I’ll talk about more below).

So using my example above, if you overinvested and put all of your money in Apple stock and the value went to zero overnight, you’d be broke. That’s not likely to happen with a stock, but with a digital asset like Dogecoin
DOGE
, it absolutely can.

2. You Could Get Hacked (Like My Colleague)

Another serious risk of overinvesting in unregulated is that you could get hacked, and more importantly, have no recourse. Just like what happened to my colleague, if you store crypto or NFTs in an online wallet, there’s going to be a risk of hacking. Even if it’s what you believe to be the most secure wallet.

And this doesn’t change if you use a cold wallet (offline storage) either. You could just as easily lose that storage device or worse, have it stolen.

Protecting yourself online is critical to begin with, but when you’re investing in digital assets, you could be talking about your livelihood. And because they’re unregulated, there is no governing body that can help you get that asset back. To reiterate – my colleague was completely out $10,000 after his crypto was stolen and there was nothing he could do about it.

3. The Actual Investment May Be Unclear

With unregulated assets like crypto or NFTs, it’s possible you have no idea what you’re investing in. Even if you think you do. To start with, the underlying technology behind crypto and NFTs (the blockchain) is a simple idea, but very complex in terms of how it functions.

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Additionally, you’re buying an unregulated asset – which means there are no rules or guidelines the creator of said asset has to follow. As we have seen with the Bored Ape Yacht club, this novelty can actually drive value, but it can also create ample space for shady business practices or mismanaged security.

For example, I worked with a freelancer to create some NFT content this past year. Super smart guy, and definitely knew a lot about the space. Months later, he launched his very own NFT. He went from creator to founder in a matter of months. Which is incredibly exciting.

But it’s also scary to think about how easily or quickly someone could stand up a new currency or NFT project, build hype around it, then completely pull the rug out from underneath all of its investors. And because it’s unregulated, guess what – there’s likely no recourse.

4. Government and Tax Unknowns

Lastly, one of the bigger risks of overinvesting in unregulated markets is simply the idea that they may eventually become regulated. I may sound like a crazy person because I just said unregulation is a risk, but the flip side of that is regulation – which can cause challenges down the road.

For instance, governments could put a high-degree of regulation around new cryptocurrencies, or even ban them altogether. Certain companies may or may not be able to produce and sell NFTs, or they may have to be registered in a different way.

Then there’s the whole idea of taxes – how are these digital assets taxed and accounted for by the governing body? The point here is we don’t know what will happen. But increased regulation around something you’d previously invested in (when there was no regulation) may cause problems that we don’t even know exist yet.

So Should I Not Invest in Crypto or NFTs?

If you take one important piece from this article, it’s that I do recommend investing in unregulated markets if they interest you, but you should approach it with caution.

Now that I’ve gotten that out of the way, let’s directly answer this – NO, you shouldn’t NOT invest in cryptocurrency or NFTs because of their risk, it just needs to be managed.

Volatile assets have a place in a portfolio – it helps bring balance (and often growth) to the portfolio as a whole, but by overinvesting in one particular area (i.e., Bitcoin
BTC
) you can hopefully now see that it may cause you some serious problems down the line.

Approach Your Portfolio With Balance in Mind

Okay, so by now you understand that there’s a lot of risk in things like crypto and NFTs. But that doesn’t mean you shouldn’t invest in them – you just need to avoid OVERinvesting in them.

So what’s a better approach?

Find balance.

Balance the high risk/high reward nature of unregulated assets with something more low risk/low reward (i.e., bonds), then round it out with more conventional investments like stocks. Here’s what I recommend, specifically:

Keep the Decentralized Darlings to 5% (10% if you’re more risk-tolerant) of Your Portfolio

If that term isn’t already coined, I’m taking it.

Realistically, you should keep things like crypto and NFTs to no more than 5% of your overall portfolio. This means if you have $10,000 to invest, only $500 should be invested in crypto or NFTs.

If you’re further along in your retirement journey and you have $100,000 in investable assets (don’t forget this includes your retirement accounts at work), that’s $5,000 to put into risky assets, which is still pretty great.

If you have a higher tolerance for risk and you can stomach the constant ups and downs of the market and the other issues I outlined above, then you can go up to 10%. I wouldn’t go any higher though. Not until we understand more about the future of how these assets will/won’t be regulated.

Keep That Same Amount In Super-Conservative Assets

By “super-conservative” I mean something that likely won’t lose value, even in a recession (this doesn’t count for inflation, so cash is out). As of this writing, I Bonds are paying more than 9%. That’s a great example of a super-conservative asset. Another idea is a CD – you won’t get a mind-blowing rate, but it’ll be conservative.

Remember – you’re not looking for risk here, you’re looking for a safety net to catch your CryptoKittie if it crashes in value. And this should mirror whatever you put into the unregulated and/or riskier assets (crypto, NFTs). So if your risk tolerance is more in the 10% category above, make sure you balance it here with conservative assets of equal amounts.

Fill the Middle In With a Blend of Stocks

If you like investing in crypto or NFTs but haven’t gotten into individual stock-picking, this part may really appeal to you.

Stock picking can be fun, but also risky. Let’s dive into how to best accomplish what should be the bulk of your portfolio. Just remember that this is a much deeper topic that is best saved for its own article, but I’ll cover the basics here.

If you want to keep this passive and have it just managed for you, I suggest either choosing a broad index fund (like VTSAX) or using a robo advisor like Betterment. If you’re more into picking cryptos and NFTs than you are researching companies and looking at financials, this might be a good option for you.

If you want to spend time researching sectors, you can invest in a broad mix of ETFs, which will give you immediate diversification. Or you can go even further and look at the company-level and pick individual stocks.

Before you start picking individual stocks for the first time, make sure you learn the basics of stock valuation and reading a stock chart.

After you understand the basics, start by picking 5-10 companies to invest in. Remember, 5-10 stocks might sound like a lot, but you want to find balance out of the gates and not overinvest in any one stock or sector.

So at the very least, pick 5 stocks from five diverse industries that aren’t co-dependent and don’t move in tandem with one another. Again, the point here is to diversify as much as you possibly can.

Finally, continue to monitor the stock portfolio – you may want to make frequent changes if you have a low number of stocks in the portfolio but I’d suggest building up a deeper portfolio of stocks across numerous industries instead of swapping stocks out constantly.

Summary

Well there you have it – some thoughts on the risks of overinvesting in unregulated markets. I have to repeat this again – I think investing in crypto and NFTs is a great idea, especially for those who love the thrill and risk side of it. The point is to balance your portfolio with less-risky assets so you don’t put yourself in a bad financial situation down the road.

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