The idea of introducing Bitcoin (and other cryptos) in a well-diversified portfolio is getting some traction. And the reason is that as Bitcoin prices have risen over the years, the FOMO or anxiety of missing out on the chance to invest in life-changing opportunity. And this is despite Bitcoin’s notorious volatility and gut-wrenching Bitcoin crash history.
So how can Bitcoin be part of one’s portfolio? Or it’s a passing fad?
At the cross wire in recent times has been the very popular asset allocation rule of 60-40.
The 60-40 Portfolio Allocation Rule has its origins in the Modern Portfolio Theory (MPT). The idea is to allocate capital among different and at times, uncorrelated assets to maximize return and minimize risk. It is easier said than done but that’s what the intent is of a 60-40 portfolio. And remember, a balanced or 60-40 portfolio is not designed to deliver the maximum possible returns. The idea is primarily to provide an acceptable return and balance it with capital preservation via adequate diversification to survive the bad days. But a 60:40 allocation may not be appropriate for everyone. There’s a huge difference in defining the correct allocation for someone looking to retire in 25-30 years compared to someone planning to hang boots in the next 2-3 years.
Coming back to our discussion.
How will 1% Bitcoin Allocation work?
Suppose you have a Rs 50 lakh portfolio. You decide to invest 1%, i.e. Rs 50,000 in Bitcoin. The remaining 99%, i.e. Rs 49.50 lakh is in a portfolio of equity and debt.
Now if in a short time your Bitcoin (+Crypto) portfolio increases 20-fold (20X), then your Rs 50,000 will turn into Rs 10 lakh. And your overall portfolio shoots up to Rs 59.50 lakh. That’s a neat move and increases your portfolio returns. But what if your cryptos go down to zero? You will still have Rs 49.5 lakh in core 99% equity & debt portfolio. As we have seen above, a 1% allocation isn’t going to materially harm you. The worst-case scenario of you losing 1% will not derail your financial goal planning or stop you from achieving your financial goals.
And from where should this 1% come from in a 60-40 Equity-Debt Portfolio? Given the riskiness, I think it should come from the equity side, i.e. 59% in equity, 40% in debt, and 1% in Bitcoin. But it can easily come from the debt side too. That is 60% equity, 39% debt, and 1% Bitcoin. It’s up to you. The idea here is pretty simple. Adding up to 1% allocation to cryptocurrencies in a multi-asset portfolio can help investors potentially achieve better overall risk-adjusted returns in this Bitcoin Era.
By the way, you can even carve out 1% each from equity and debt and have 2% in cryptos and 59% and 39% in equity and debt respectively. You need to decide your position sizing on your own (or talk to an investment advisor). But I think given the wild nature of the cryptos, at all times, you need to keep it below 5% unless you are really an expert in the field and operating in your circle of competence.
Further Reading – What portfolio percentage to invest in Bitcoin?
But what if for your 1% exposure, you don’t want to just invest in Bitcoin? So how can you split your cryptocurrency portfolio % between Bitcoin, Ethereum, and other Altcoins?
I have written about in detail in Splitting portfolio amongst Bitcoin, Ether & Altcoins. My view is that for a portfolio with a major part in Bitcoin + Ethereum (like 70-80% or more), the basic idea is to capture consistent and long-term gains via the 2 main bets in Bitcoin and Ethereum. The altcoins, on the other hand, provide the potential for outsized gains (5x – 100x type returns) in the near-medium term. This is one way to have a sort of Balanced crypto portfolio 2021 to maximize gains but minimize potential losses in your crypto portfolio.
Some argue that Bitcoin will do better than gold in years to come so it’s better to have a larger allocation to Bitcoin than to gold. But I think that it’s not right to compare Gold and Bitcoin. Bitcoin isn’t exactly the New Gold 2.0. Gold has been doing what we expect it to do for us for decades. Bitcoin is something else.
And unless you know what you are really getting into, don’t try to day trade in Bitcoin or cryptos. Try to hold it for the long term as a 60-40 portfolio is also designed primarily for the long term. No one knows where Bitcoin price will be in 10 years. But if the bullish case is what luckily plays out, then you wouldn’t want to be out of it when that happens. So be ready to HODL for years even decades, through periods of volatility as the space ages and matures. So look to buy Bitcoin for next 10 years atleast.
The Bitcoin narrative is gradually finding its way to more and more young investor’s portfolios. Some are casually putting money in it to ‘try their lucks’. But a small number is looking at it as a serious contender for the role of Alternative Investment options. And from the back-testing studies based on historical data, it is clear that adding Bitcoin to a traditional portfolio would have impacted the overall returns positively.
The role of crypto in a broader portfolio is still being debated. From the historical data, it does seem that an allocation of 1% to Bitcoin (or a basket of different cryptocurrencies) can boost risk-adjusted returns without taking on too much exposure.
But I think everyone should think for themselves. You need to think hard about whether should you invest in Bitcoin or not? If not then, it’s perfectly fine. This space is not for everyone. Acknowledge that and move on. Stay with traditional assets like equity, debt, real estate, gold and cash. But if you decide to dip into it eventually, you need to figure out how to put crypto in its rightful place in your portfolio. Start small. Having a 1% Bitcoin allocation is a kind of getting into a Bitcoin Starter Pack, if I may call it that. Also, remember that super-normal past returns may be a thing of the past. With a bigger base effect, you might need to be a bit realistic about those future returns from Bitcoin.
I know many are still skeptical about cryptocurrencies as a whole. And they may be right eventually. Even I am very cautious as I am still in the learning stage. But in general, I think that atleast for some people there’s nothing wrong with taking risks, in general. Taking calculated and sensible doses of risk is very different from being outright rash. And if you’re right, then it will have a material positive impact on the portfolio. On the other hand, if you’re wrong, it won’t hurt you or the portfolio very much due to small allocation.
Bitcoin is still a very volatile and speculative investment vehicle. Though bulls and bears have chosen their sides about what is in store for Bitcoin’s future, the fact is that no one has any reliable Bitcoin price prediction to make. Will it rise further, will it time-correct, will it price-correct? No one knows. So keep that in mind when you think about increasing the 1% Bitcoin allocation any further.
Once there is regulatory clarity about the legality of Bitcoin and you decide to go ahead with cryptocurrencies, then start small. Like a few thousand Rupees or keeping it below 0.5%-1% of the overall portfolio. Don’t bet big on the first day.