3 Questions before you get serious about investing in Bitcoin

At first, people invest just a very small amount of money (a few thousand Rupees) in Bitcoin to start their journey. To get a feel. Then they realize, that there are other promising cryptocurrencies (or Altcoins) as well. As their interest further grows, they get serious about the whole thing.

And when that happens with you, it is time to ask 3 important questions from yourself.

What are these questions? And why are they important? Let’s discuss this in the rest of the post.

Question 1: How long should you hold to Bitcoin? What should be the holding period?

Some people believe that it’s better to do short-term trading in Bitcoins and those who are planning to hold (or HODL) it for years if not decades. It goes without saying that Bitcoin is a volatile instrument/asset. It’s not easy to adjust to its sharp moves.

How sharp?

  • Intra-day rise and falls of 25% or more
  • Four instances of 80% drop within a year in the past decade (read about Bitcoin crashes to know more).
  • Several drops of 50% or so in a matter of weeks

Do you see?

And still, it’s up from $0.00076 (or a mere Rs 0.05) in 2009 to its all-time high of $64,000 or Rs 47 lakh per Bitcoin! (An amount that is enough to buy a decent 2BHK in India).

Volatile? Yes, extremely. Profitable? Nothing like it for those who stayed with it. Infact, I personally know a Bitcoin crorepati who is still holding on to a life-changing stash in Bitcoin till day.

Infact, inspite of the volatility, BTC investing and holding has rewarded investors who stay put. Here is a graph of the Number of Profitable Days holding Bitcoin, i.e. it shows the number of days in Bitcoin’s traded history where holding Bitcoin has been profitable relative to today’s price. As you can see in the chart below it stands at 96.4% as of now.

Bitcoin Profitable Days Percentage

There have also been detailed studies that show that there is a generally positive contribution to a portfolio’s returns r over all time periods for Bitcoin. Infact, if held for more than 3 years, Bitcoin makes almost 100% positive contribution to portfolio outcomes. For a shorter time horizon, there are sufficient risks for a negative loss-making BTC outcome.

So the basis of historical data and other evidence, it seems that holding on to a Bitcoin allocation in the investment portfolio is profitable.

So if you were to ask me, I would suggest that instead of looking to buy and sell regularly and try to trade your way to profit, it’s better to invest in BTC for long and hold on to it. Ofcourse it can turn out to be wrong. But as per the given evidence and potential to hold Bitcoin for 10 years, it seems to make sense.

Note – It is another matter whether you should even invest in Bitcoin or not. It’s not for faint-hearted. It’s not for everyone. But if you think it’s worth a shot, then holding on is a better bet I think. I also have a bias for long-term holding in equity investing.

Question 2: How often to Rebalance your Bitcoin Allocation?

Given the volatile nature of Bitcoin, its allocation in the portfolio can suddenly grow to a significant percentage during a run-up.

Suppose you start with a 2% allocation to Bitcoin in a Rs 10 lakh portfolio, i.e. you invest Rs 20,000. But over the next few months, Bitcoin does a 10x, i.e. rises by 1000% or becomes 10 times (it has happened in past). In that case, suddenly, your Rs 10,000 becomes Rs 2 lakh. Now, this forms almost 18-20% of your Rs 11 lakh portfolio.

What should you do now?

You have few options:

  • Do nothing
  • Do monthly rebalancing
  • Do quarterly rebalancing
  • Do yearly rebalancing

To be fair, if you look at the past data, then ‘no rebalancing’ leads to higher profits! And that is even when you compare it with a very active and extremely nimble Crypto engine or trading algorithm. The trajectory of Bitcoin price, inspite of its crash history, is such an upward sloping line.

But doing any sort of rebalancing exercise (monthly, quarterly, or annual) can no doubt lower the volatility impact on the portfolio dramatically. But it will also reduce the returns accordingly. And it’s not surprising. Bitcoin is a highly volatile but upwardly biased (till now) asset. So lower rebalancing frequencies generally lead to higher volatility, higher cumulative returns, and significantly higher maximum drawdowns. As a result and as a corollary, a more frequent rebalancing strategy will dampen both returns and the volatility one experiences.

So depending on what you are comfortable with and what allows you to sleep peacefully at night, decide to either just buy-and-hold and let the BTC run its course, or regularly rebalance and book profits and plow them back into traditional assets like equity, debt or even gold (which Bitcoin is often compared with as the New Gold 2.0).

That brings us to our last question.

Question 3: How much should be Bitcoin’s Allocation in your overall Portfolio?

I think this is the most important question to ask yourself if you are getting serious about it. Investing a few thousand with money you can afford to lose is fine. But if you are looking at Bitcoin as a viable option to park your portfolio, then you need to get serious and ask tough questions.

My suggestion would be to first gradually build it up to 1% of your overall portfolio.

Why just 1% and not more there is a good chance of Bitcoin rising a lot in the future? 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.

But should you invest this 1% in only Bitcoin or a basket of other currencies (Altcoins) as well?

I think sticking with established cryptos Bitcoin and Ethereum is better than chasing all the new coins in news. Many Crypto billionaires hold hundreds of cryptocurrencies but they have 80-90% in Bitcoin and Ethereum only as they themselves are not sure about which will do well and which will go bad. So they too spread their bets with a major chunk in comparatively safer ones.

There is also a statistical model that many use to decide How Much Crypto Should Be In Your Investment Portfolio? It is called The Black-Litterman Model. The name might sound intimidating but it’s pretty simple and actually interesting to read about. Here is a short summary (link).

So in your journey to having 1% Bitcoin, you will pass through the following phases:

  • No investment in Bitcoin
  • Let’s try. So invested just a few thousand Rupees in Bitcoin
  • Invested more and now have 0.10% in Bitcoin
  • Invested more (or BTC price rose) and now have 0.20% in Bitcoin
  • Invested more (or BTC price rose) and now have 0.30% in Bitcoin
  • Invested more (or BTC price rose) and now have 0.40% in Bitcoin
  • Invested more (or BTC price rose) and now have 0.50% in Bitcoin
  • Invested more (or BTC price rose) and now have 0.60% in Bitcoin
  • Invested more (or BTC price rose) and now have 0.70% in Bitcoin
  • Invested more (or BTC price rose) and now have 0.80% in Bitcoin
  • Invested more (or BTC price rose) and now have 0.90% in Bitcoin
  • Invested more (or BTC price rose) and now have 1% in Bitcoin

To be honest, if you look at the past data about cumulative return figures, you will say that the more Bitcoin the better it is. But don’t look at this Bitcoin allocation decision only from the lens of returns. It can get real ugly real fast.

Also as the Bitcoin allocation increases, the portfolio’s volatility also begins to increase. And once you decide to stretch in above 1%, that is go for 2% in Bitcoin, 3% in Bitcoin, 4% in Bitcoin and 5% in Bitcoin, it will also begin to show its face in your overall portfolio’s maximum drawdown. You might be too excited to increase Bitcoin exposure due to its life-changing return potential, but I think for small investors it’s best to keep it within 1-2% for the time being. And always consider the maximum drawdowns when sizing your portfolio’s Bitcoin allocation.

So those were the 3 important questions about holding time period, rebalancing approach and allocation or position sizing in Bitcoin

From what we have seen till now, I think that once the legal nature of Bitcoin is established, it might have a unique role to play in enhancing a portfolio’s risk-adjusted returns. But it should be dealt with extreme caution.

Leave a Reply