Diversification Distribute Your Investments
Diversification is a very old and often cited principle of investing. We could go into the mathematical details here which show the effects of diversification very precisely. But we rather want to give
you a hands-on approach that you can apply as a lender on Bit bond without the need to study statistics beforehand.
Diversification in finance simply means that you place many smaller bets instead of a few big bets. This strategy should yield a decent average return that lets you sleep at night quietly at the same time. If you place only one bigger bet, the potential return might be large, but the same applies to the potential loss. Bitcoin lending on Bit bond should yield a return of approximately 10% p.a. in a diversified portfolio of bit coin loans. So how do you diversify?
Amount per loan
The minimum amount that you can invest per loan is pretty small at currently 0.01 BTC. We kept this minimum amount so small on purpose. That way you can build a portfolio of 100 loans with an investment of just 1 bitcoin. We recommend not to invest much more than the minimum amount into one loan.
Generally, we advise to stick to the following 2 rules of thumb:
1) Only fund 20% or less of the requested loan amount. So if it’s a very small loan of just 0.1 BTC, don’t put more than 0.02 BTC into this loan.
2) Let one single loan comprise only 5% or less of your portfolio. So if you plan to lend a total of 2 bitcoins for instance, then you shouldn’t put more than 0.1 BTC into one loan (since 2 x 5% = 0.1). You can check your total investment in your investment overview – it’s the bold figure in the ‘Total outstanding principal’ column.
Diversification has more than just the investment amount dimension. It is also good to diversify other aspects of your loan portfolio. One cool thing about global bitcoin peer-to-peer lending is that there are loan listings from many different countries.
Despite the fact that economic cycles tend to follow a global trend, the economic environment varies from country to country. While one region might be in recession, another part of the world might still experience a dynamic economic activity. When times get tough, defaults on debt also tend to increase. Therefore it makes sense to have a geographically diverse loan portfolio.
Bitcoin lending is still quite young so not all countries might be equally represented in our listings. But the opportunities are growing daily. We recommend building a portfolio where one country makes up 30% or less of the entire portfolio in value terms. Ideally, it should be less.
Loans on Bit bond have terms between 6 weeks and 5 years. Generally, loans with a longer duration have a higher default probability. A longer time horizon brings more uncertainty. Therefore a longer duration is always reflected in a higher interest rate compared to a shorter duration.
Holding different loan investments with different terms makes mainly sense for one reason. Your capital tie-up is not concentrated over one specific term. When you have a basis of longer dating loans and another portion of shorter dating ones you can act more flexibly. If you don’t need immediate liquidity you can re-invest cash flows quickly. Otherwise, you can keep the liquidity and have it ready for consumption.
On the other hand, if you only hold short-term loans you have to put more effort into actively managing your portfolio. This can certainly be fun, but you need to have the spare time to do it.
Each rating category represents a different default risk. Higher interest rates reflect the increased risk of lower ratings. Therefore the average returns from different rating categories should be roughly in the same range.
But to make the most of our risk-based pricing method (a blog post about this will come soon), diversify between rating categories. Ideally, you have only about 20% of your loan investments in each rating category A to E.
If you want to concentrate your portfolio a little more towards one or the other end we still recommend at least keep the concentration below 40% in one rating category. This should also be based on value instead of a number of loans.