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Adding Bitcoin to your investment portfolio might positively impact your long-term returns, but it’s all a matter of timing.
A CFA Institute Research Foundation report looked at the impact of Bitcoin on a diversified portfolio between January 2014 and September 2020. Over this period, a quarterly rebalanced 2.5% allocation to Bitcoin improved returns from a traditional portfolio by nearly 24%.
That’s a massive impact from a tiny allocation. It’s also hardly surprising: Bitcoin appreciated by approximately 2,875% over the period.
Be very careful with findings like this, which can make it seem like the more crypto you buy, the better. That’s only really true for early adopters—say, if you’d added the same amount of crypto in December 2020, the impact through July 2022 would have been just about zero.
You can get too much of a new thing, and that’s especially true of cryptocurrency. Let’s look at how much crypto you should have in your portfolio.
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Most experts agree that cryptocurrencies should make up no more than 5% of your portfolio.
This amount is “small enough to keep an investor comfortable in periods of high volatility, but also large enough to have a truly positive impact on the portfolio if crypto prices rise,” says Bruno Ramos de Sousa, head of global expansion at Hashdex.
Some experts, such as Aaron Samsonoff, chief strategy officer and co-founder of InvestDEFY, allow for allocations as high as 20%. But how much crypto should be in your portfolio ultimately depends on your risk tolerance and beliefs about crypto.
In addition to outsized long-term returns, cryptocurrencies tend to have excessive volatility.
In the case of the CFA Institute study, the larger the allocation to Bitcoin, the higher the return and the greater the volatility. Between January 2014 and September 2020, the traditional portfolio without Bitcoin yielded a 6.26% return versus the traditional portfolio with a 2.5% Bitcoin allocation, which produced an annual return of 8.6%, which also saw increased volatility.
“The potential for outsized returns coupled with the significant risks of this emerging asset class means that a very small allocation is sufficient,” says Ric Edelman, founder of Digital Assets Council of Financial Professionals and author of “The Truth About Crypto.”
Experts say that a small amount can materially improve your overall returns without leaving you at risk of financial harm if your cryptocurrency investment declines significantly or even falls to zero.
“Adding some to your portfolio can be a great way to really take advantage of long-term gains while knowing that if you don’t make it big, you aren’t out your whole investment portfolio,” says Callie Stillman, partner at Lift Financial.
Once you’ve decided how much cryptocurrency to own, the question becomes which crypto assets to buy and how much to hold.
Edelman suggests four crypto portfolio options. First, you could own Bitcoin only. It’s the oldest and largest digital asset in crypto market dominance.
“When institutions invest, they typically buy only Bitcoin. It might not produce the highest gains, but it’ll be the last to go to zero,” he says.
As Bitcoin’s market dominance fades, it’s increasingly important to diversify your position to capture the complete crypto opportunity set, says Martin Leinweber, digital asset product strategist at MarketVector Indexes.
“Different assets deliver notably different return patterns and respond heterogeneously to Bitcoin pullbacks,” says Leinweber. “While short-term correlations can be high, longer-term “Bitcoin has nothing to do with a gaming token such as Axie Infinity or an exchange token such as Binance Coin (BNB).”
A popular alternative to Bitcoin is Ethereum, the second largest cryptocurrency by market cap, with 18% market dominance. “Many believe it has far greater utility for global commerce and therefore will continue to gain in prominence,” Edelman says. Many other coins and tokens also rely on the Ethereum blockchain.
You could also have a portfolio that includes a mix of Bitcoin and Ethereum. “They are the Coke and Pepsi of crypto,” Edelman says. Between them, you have more than 60% of crypto’s market share.
Edelman suggests a 50-50 split or 60-40 favoring your preferred coin. “Otherwise, you’re making a big bet,” and “bets should be avoided as this asset class is plenty risky already.”
While larger coins like Bitcoin and Ethereum may make up a larger share of your portfolio, keeping smaller proportions of other crypto assets can improve your long-term returns, Leinweber says.
Directly owning crypto is no longer your only option for investing in the space. There is a variety of Bitcoin ETFs and blockchain ETFs that provide a simple way to get crypto exposure in your portfolio.
Edelman points to the Bitwise 10 Crypto Index Fund (BITW), a market cap-weighted ETF of the 10 largest digital assets. Being market-cap weighted means Bitcoin and Ethereum make up the bulk of the fund at more than 90% of the total portfolio.
“Most passive crypto investors would be best suited to focus on Bitcoin, Ethereum and/or a crypto index fund,” Samsonoff says. “Single name blockchains and projects, even the larger ones, still have a lot of tail risk and on a risk-adjusted basis, it is hard to outperform Bitcoin, Ethereum, or an index unless you are an active researcher in the space.”
Leinweber suggests a multi-token fund replicating a market cap-weighted index to ensure you get the crypto market return.
“You’re implicitly buying the winners and selling the losers,” he says, with the asset manager doing the job for you and replicating the index.
Some crypto ETFs invest in publicly traded companies engaged in the crypto industry, such as crypto exchange Coinbase, crypto bank Silvergate Bank and Bitcoin mining company Riot Blockchain, rather than buying the cryptocurrencies directly.
Investment companies also provide separately managed accounts (SMAs), which are like personalized mutual funds that own up to two dozen different cryptocurrencies.
“The account is managed specifically for you, with a truly personalized approach to rebalancing and tax-loss harvesting that you can’t do with funds,” Edelman says. The challenge to SMAs is they usually have investment minimums as high as tens of thousands of dollars.
Stillman says that your crypto portfolio should look just like any other part of your investment portfolio. It should be diversified and match your risk tolerance.
You should use cryptocurrencies that you’ve researched and feel comfortable investing in. “Read the whitepapers on them to better understand how they work and their objective,” she says. “Dig into who is behind them and know their track record.”
An important question is why you’re buying crypto and your plans. Are you buying because your friends told you to? Is it for the short- or long-term gain? What are you planning on doing with any gains you earn? “Some crypto is liquid, and some is not,” Stillman points out. “How important is that to you?”
A good crypto portfolio lets you hold it through bear and bull markets without losing sleep at night. “If the crypto portion of your portfolio is sized too large or concentrated in speculative altcoins, you risk having paper hands,” a term used to describe investors who sell out of fear at the first sign of a downturn, Samsonoff says.
“Inversely, if you are sized too small, you risk getting greedy as confirmation bias kicks in after crypto has been rallying, and you potentially buy into a top after feeling sidelined on the way up,” he says.
Keeping a long-term perspective, meaning years and decades, is the key to managing your crypto portfolio. “This is a new and thus very volatile asset class, and you should focus on the potential for profits over decades, not weeks or months,” Edelman says.
Leinweber says that portfolios over a four-year or longer period are generally in profit. “It’s an investment in a new technology and not a get-rich-quick scheme.”
Many experts recommend using a dollar-cost averaging strategy where you buy or sell a fixed dollar amount regardless of what happens. This can take emotion out of the equation.
“Trying to time the market perfectly or checking your portfolio every day in general leads to more stress and bad decision-making. Instead, it is better to have periodic reevaluations of your positions and rebalancings based on your evolving view of the market, not much different from a stock portfolio,” de Sousa says.
Otherwise, your cryptocurrency allocation could overwhelm your portfolio and increase your overall risk.
“If you’re not an active trader, you should have a steady percentage allocation to crypto and rebalance to your target weights monthly or quarterly,” says Greg King, founder, and CEO of Osprey Funds.
Tracking your crypto portfolio can be a challenge.
The most important advice when tracking your crypto portfolio is to align your thesis time frame, Samsonoff says. Know your trigger for entry and exit before you get started.
“Without a clear plan, you will have your conviction—or lack thereof—tested and succumb to emotional decisions based upon volatility of the crypto space,” he says.