With so many new people entering the crypto and traditional finance world every day, I think it's important to clarify the different types of involvement you can have within these industries. Some of the more experienced people in these activities may already be aware of the differences. However, it never hurts to refresh your mind of old and potentially new knowledge and reevaluate your current strategy to see if any improvements can be made. So, let’s get into it.
We must first clarify the things that are universal among investors; the variables people deal with, their expectations, and their goals. Everyone’s circumstances are different, and therefore their financial strategy will be different. Ask yourself these questions to understand where you stand and the approach you should take.
Time Horizon: This aspect usually depends on when you think you’ll need access to the money. It's smart to have different accounts that are dedicated to something specific. For instance, you can open a retirement account that is catered toward when you no longer work. If you are young, then you should put more long-term investments in this portfolio. If you are older, and retirement is coming up soon, then you should put short-term investments within your portfolio. But retirement isn’t the only thing that you need to save for. Maybe you have a house, car, wedding, or other major purchase goals that you need or want. Therefore, accounts should be available that are liquid, so you can have access to the money when you want. These are just a few examples of different accounts with different timelines that you should consider.
Risk Tolerance: Risk tolerance is related to time horizon because the longer the investment time horizon, the more exposure to risk people should have. However, there are other things you should consider and a number of quizzes and tests you can take to get an accurate risk tolerance for yourself. It usually goes from a scale of very conservative to very aggressive. Another thing to consider to understand risk tolerance is the need for liquidity. Usually, riskier investments are more illiquid and therefore more difficult to access the funds if needed. Another thing to consider when evaluating risk tolerance is what are your overall goals and how close to achieving those goals are you given the status-quo? Are your goals to retire, move in a cabin up north and hunt for your food? If that’s what brings you happiness and a sense of success, then you probably won't need to be extremely risky in your investments, because the capital required for that is low. However, if you want to leave a sizeable bequest to a charity or your kids and you don’t have the money given the status quo to make that happen, maybe a reevaluation of your risk tolerance is necessary. There are other variables to consider, but generally assessing your liquidity needs and overall goals will lead to you understanding how risky you should be.
Return Desired: Like the risk tolerance is related to time horizon, return desired is related to risk tolerance. Once the tolerance for risk is established, the returns desired must be accessed. This will require some form of financial planning or analysis and more than likely a special software dedicated to taking into consideration compounding, inflation, and returns. You can do it by hand on an excel spreadsheet or even on paper, but it would make it more difficult. return desired should be sufficient enough to live off taking around 3-5% of your account value per year during retirement. Overall, around 70-80% of your pre-retirement income should be replaced and on average around 3-5% is withdrawn from people’s retirement accounts in the years that they’re not working. Therefore, getting a high average return will allow people to continue to grow their portfolio, even after taking out 3-5% of their account, and will allow your principal to compound.
Now that we’ve established some baseline variables that are universal between every investor, we can begin the conversation about the different types of ways to use your money.
Investing
Investing is the first and most basic thing that people do within the traditional and crypto markets. Investing means having a long-term time horizon, where you don’t check the price every day. In order for this to become a reality, you must have conviction behind the project or company that you’re investing in. This takes time and research. Learning about the team in charge, the real use-cases and the value that’s being added to the world is just some of the baseline questions you should be asking before putting money into a project for the long term. Looking at the company’s narratives, financial statements, and road maps are more things to consider and should all have different weights depending on your timelines and capital invested.
Trading
Trading is a much smaller timeline and usually involves a combination of fundamental and technical analysis. Some people trade on an hour timeline, days, weeks, or months. However, what’s objective is that the timeline for trading is much smaller and is popular for making short-term gains. There is a variety of different forms of technical and fundamental analysis and it's important to understand the differences, uses, and importance of each respective tool.
Speculating
Investopedia defines speculating as the “act of conducting a financial transaction that has a substantial risk of losing value but also holds the expectation of a significant gain or other major value.” A good example of this would be investing in a dog coin. You only have the possibility of losing 1x, however, you have the ability to gain 10x. 100x or more. Normally, people don’t have a lot of conviction in the project and are much more worried about volatility in the price or news of the project. Again, speculation has a much shorter time horizon than investing and is usually considered a method of earning short-term profits.
Gambling
Gambling is defined by Investopedia as, “staking something on a contingency. Also known as betting or wagering, it means risking money on an event that has an uncertain outcome and heavily involves chance.” Gambling involves relying on a third party that you have no control over to accomplish or not accomplish a certain task. A good example is sports betting or slot machines. This is the riskiest form of money spending because you have no control of what the outcome will be, and more often than not, once your initial capital is put in, there is no getting it out.
None of this is financial advice, but it is some baseline review of what different types of financial actors do inside of markets and how you should view different activities in the news, social media, and other sources of information.
Other things to remember: DYOR. Concentration creates wealth, diversification protects wealth. When the streets run blood, that’s when it’s time to buy. Buy low, sell high; not necessarily in that order.
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