How Much of Your Portfolio Should You Allocate to Bitcoin?

What proportion of a well-rounded investment portfolio should be made up of Bitcoin? The answer depends on many factors: your financial circumstances, how comfortable you are with Bitcoin’s price fluctuations, and whether you are seeking long or short-term returns. In this article, we offer an overview of the various elements you may want to consider.

Does anyone remember when traditional investors didn’t take crypto investment seriously? Anyone who has watched the crypto trends lately will know that things have changed. With several key developments recently including a 100% climb in the crypto market cap from July to September, and El Salvador adopting Bitcoin as legal tender, there’s no doubt about it. Crypto is here to stay.

Traditional investment bodies have increasingly sat up and taken notice. This summer, financial analysts Coalition Greenwich found that seven out of ten institutional investors plan to purchase crypto soon. 

As the original cryptocurrency, Bitcoin, remains the world’s most popular crypto, even though many other contenders have arisen since its creation. If you only have a small amount of money to invest in crypto, Bitcoin may be your best bet.

How much of your portfolio should be dedicated to Bitcoin?

For those who have opted to go all-in on Bitcoin, there is only one answer to this question: 100%. The most enthusiastic Bitcoin devotees have a single aim: hold as much of the cryptocurrency as possible. However, if you are more inclined to exercise caution and distribute your investments across a diverse range of assets, deciding on your Bitcoin portfolio allocation is a matter of considering your own personal circumstances and choosing a percentage you feel comfortable with.

The wisdom behind holding a diverse portfolio is that different segments of your portfolio can compensate for other segments, especially if you take care to hold a range of uncorrelated (or negatively-correlated) assets. This helps ensure that your nest egg will remain intact, no matter which of your assets may be hit by random shocks – either positive or negative. The old adage of not placing all of your eggs into one basket comes to mind.

The 5% Club

The most common Bitcoin allocation figures floating around in traditional finance circles tend to fall between 1% and 5% of your total wealth.

In the rapidly shifting world of cryptocurrencies – where the value of the coins you hold can change drastically over a short period of time – it’s prudent to have a rule in place for when to rebalance your portfolio, and by how much. Many investors choose to rebalance their Bitcoin assets into other holdings every time Bitcoin significantly increases in value. However, this short-term strategy can cause them to miss out on the long-range benefits of that increased value.

Market volatility is a common concern for Bitcoin investors, but long-term trends point to an upward trajectory for the crypto asset. Amy Arnott, writing for Morning Star, analyzed the impact of adding different percentages of Bitcoin to an all-equity portfolio: measuring the results over a three-year period ending in December 2020.

Over the three-year period, Bitcoin showed more than four times as much volatility (as measured by standard deviation) as equity market indexes. Bitcoin’s low correlation with the equity market, however, meant that the cryptocurrency’s presence in the portfolio didn’t significantly increase the overall volatility of the portfolio. Even a 10% Bitcoin weighting (the highest percentage measured in the analysis) would have increased the portfolio’s standard deviation by a fairly moderate amount. Higher, Bitcoin returns more than offset the added volatility.

A ten-year analysis demonstrated more mixed results, revealing that Bitcoin’s standard deviation was more than 15 times that of the equity market. Again, both risk and returns increased with larger Bitcoin weightings.

Arnott commented, “deciding on an appropriate Bitcoin weighting partly depends on whether you think the future will look more like the recent past, or more like the trailing 10-year period. Much of Bitcoin’s eye-popping 10-year record owes to an off-the-charts runup from 2011 through 2013, when the CMBI Bitcoin TR index posted annualized returns of more than 1,000% per year, including a gain of more than 5,300% in 2013 alone. These gains may not be repeatable, partly because trading volumes in Bitcoin have increased nearly 3,000-fold since 2014. On the positive side, volatility has significantly decreased, although Bitcoin’s standard deviation remains more than four times higher than that of the broader equity market.”

Investment expert William Baldwin, writing in Forbes, pointed out that it is difficult to make sweeping pronouncements about Bitcoin’s future, as it is a young asset in comparison to traditional stocks and bonds: “Bitcoin’s history is short. It is one thing to look back on a century of history for stocks and bonds and draw conclusions about how much return and how much volatility you can expect from them. It is quite another to extrapolate anything from the freakish first decade of a virtual object.”

Bitcoin’s long-term prospects look positive

For regular people who wish to build solid returns on their investment over decades, Bitcoin’s price volatility seems to have little impact on the overall financial case for this asset. Bitcoin’s Sharpe ratio (its returns in relation to its volatility) routinely outperforms most other assets.

So what does all this mean for you and your portfolio?

It’s important to bear in mind that any financial advice you find online is, by its very nature, generic and is not always applicable to your own situation, and this advice is no different. 

To recommend a blanket Bitcoin portfolio allocation of 1%, 5% or more is to ignore several key elements of an individual’s life and financial circumstances, that you must think about for yourself:

• Timing: when investing in Bitcoin, do you have any particular timeframe in mind when you intend to use the funds? At what age do you plan to retire? How much of the asset do you wish to use during your lifetime, and how much do you wish to pass on to your heirs?
• Income Security: How much do you earn? How much does your spouse earn? How many dependents do you have? Common sense applies here, as it does in all other areas of your life. Don’t spend all of your money on Bitcoin if it means your family can’t eat!
• Risk Tolerance: Are you comfortable with watching the value of your investments increase and decrease over short or medium timeframes? If you become extremely stressed out by sharp downturns in the price of your assets, you may wish to start small and allocate a tiny percentage of your portfolio to Bitcoin and gain a better understanding of the crypto sphere before investing further.

Ultimately, your Bitcoin portfolio allocation is much more complex than picking a single digit that will never change. Your personal circumstances must be considered carefully before you commit to any specific amount.

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