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Bitcoin is the oldest cryptocurrency and it was invented in 2008, which is to say this is still a young asset class. Still, it feels as though for as long as crypto has been around, so has the debate surrounding its inclusion in investment portfolios and if that question is answered affirmatively, that sparks debate regarding how much of a portfolio should be allocated to digital currencies.
For the purposes of this article, bitcoin will be the point of emphasis because it’s the largest digital currency, the one that’s most heavily traded, most accessible in fund form and because the universe of cryptocurrencies is densely populated with a lot of garbage. Figure it this way: at this writing, the 100th-largest digital currency is a memecoin inspired by a dead squirrel. By comparison, the 100th-largest member of the S&P 500 is Analog Devices (ADI) – a mature technology company.
With those disclaimers in mind, various studies confirm that 60/40 portfolios that trim the fixed income sleeve in favor of modest bitcoin allocations outperform portfolios with no crypto exposure. However, the rub is that cryptocurrency isn’t suitable for all clients. The portfolio of a 30-year-old client has the luxury of time to ride out the volatility inherent with crypto and that is to say a strong case can be made that crypto, even in small doses, probably doesn’t belong in a baby boomer portfolio.
Speaking of Volatility…
Anyone that’s even casually paid attention to bitcoin and friends has likely noticed the breathtaking declines and surges, often in short timeframes. That presents investors with a quagmire: deal with the turbulence or miss out on returns that often beat those of traditional asset classes.
“Crypto’s appeal has largely been its alpha generation potential, but even here challenges persist. While Bitcoin’s returns have been impressive, they’ve come with extraordinary volatility, four times that of the S&P 500,” notes J.P. Morgan Asset Management (JPAM). “Moreover, unlike Bitcoin, equities are driven by predictable fundamentals, such as revenue and earnings growth, which analysts can forecast to estimate future performance. This makes them more reliable for long-term investment goals.”
Making allocations to crypto all the more tricky is aside from the digital currencies that allow for staking, it’s generally hard to generate income with asset class. Some advisors might argue if there’s no income on the table, why not just opt for gold, which is significantly less volatile than bitcoin.
“Most crypto assets, including Bitcoin, generate no income and Bitcoin in particular has been a poor diversifier: its three-year rolling correlations with stocks and bonds are both positive, as most cryptocurrencies have behaved like risk assets with hyper-sensitivity to interest rates since 2020,” adds J.P. Morgan.
It’s All About Risk
Advisors know they’re fiduciaries meaning clients’ best interests are central to their everyday missions. A big part of that equation is ensuring client portfolios are constructed in fashion that meshes with the client’s individual risk tolerance.
Translation: keep it small and realize the audience of clients that have adequate risk tolerance for crypto is still small.
“As a result, for most investors, any allocation to crypto in a portfolio should be kept both small enough to ensure that even in the event of a significant sell-off it does not derail overall portfolio objectives and well diversified,” concludes JPAM.