Adding Bitcoin to your investment portfolio can have a positive impact on 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. During this period, a quarterly rebalanced 2.5% allocation to Bitcoin improved the return of a traditional portfolio by nearly 24%.
That’s a huge impact from a small grant. It’s hardly surprising, either: Bitcoin appreciated by roughly 2,875% during the period.
Be very careful with findings like this, which can make it seem like the more crypto you buy, the better. That’s really only true for early adopters – say if you’d added the same amount of crypto in December 2020, the effect through July 2022 would have been about zero.
You can get too much of a new thing, and that is especially true of cryptocurrency. Let’s look at how much crypto you should have in your portfolio.
How Much Crypto Should You Own?
Most experts agree that cryptocurrencies should not make up more than 5% of your portfolio.
This amount is “small enough to keep an investor comfortable during periods of high volatility, but also large enough to have a really positive impact on the portfolio if crypto prices rise,” says Bruno Ramos de Sousa, head of global expansion at Hashdex.
Some experts, like Aaron Samsonoff, chief strategy officer and co-founder of InvestDEFY, allow allocations as high as 20%. However, how much crypto should be in your portfolio ultimately depends on your risk tolerance and faith in crypto.
In addition to outsized long-term returns, cryptocurrencies tend to have excessive volatility.
In the case of the CFA Institute study, the greater the allocation to Bitcoin, the higher the return and the greater the volatility. Between January 2014 and September 2020, the non-Bitcoin traditional portfolio returned 6.26% versus the traditional portfolio with a 2.5% Bitcoin allocation, which returned 8.6% annualized, which also saw increased volatility.
“The potential for outsized returns combined with the significant risk of this emerging asset class means that a very small allocation is sufficient,” said Ric Edelman, founder of the Digital Assets Council of Financial Professionals and author of “The Truth About Crypto.”
Experts say that a small amount can significantly improve your overall return without risking financial damage if your cryptocurrency investment drops significantly or even drops 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 go big, you’re not out of your entire investment portfolio,” says Callie Stillman, partner at Løft financial .
What should my crypto portfolio look like?
Once you have decided how much cryptocurrency to own, the question becomes which cryptoassets to buy and how much to hold.
Edelman suggests four crypto portfolio options. First, you can only own Bitcoin. It is the oldest and largest digital resource in crypto market dominance.
“When institutions invest, they usually just buy Bitcoin. It might not bring the highest gains, but it will be the last thing to go to zero,” he says.
As Bitcoin’s market dominance fades, it’s increasingly important to diversify your position to capture the full crypto opportunity set, said Martin Leinweber, digital asset product strategist at MarketVector Indexes.
“Different assets notably deliver different patterns of returns and respond heterogeneously to Bitcoin withdrawals,” says Leinweber. “While short-term correlations may be high, long-term “Bitcoin has nothing to do with a gaming token like Axie Infinity or an exchange token like Binance Coin (BNB).”
A popular alternative to Bitcoin is Ethereum, the second largest cryptocurrency by market capitalization, with 18% market dominance. “Many believe that it has far greater utility for global trade and will therefore continue to gain prominence,” says Edelman. Many other coins and tokens also rely on the Ethereum blockchain.
You can 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 or 60-40 split that favors your preferred coin. “Otherwise you are making a big bet,” and “gambling should be avoided as this asset class is already very risky.”
While larger coins like Bitcoin and Ethereum can make up a larger portion of your portfolio, holding smaller portions of other crypto assets can improve your long-term returns, Leinweber says.
Check out crypto ETFs
Owning crypto outright is no longer the only option for investing in the space. There are a number of Bitcoin ETFs and blockchain ETFs that provide an easy 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 that Bitcoin and Ethereum make up the bulk of the fund with 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,” says Samsonoff. “Single-name blockchains and projects, even the larger ones, still have a lot of tail risk, and on a risk-adjusted basis, it’s hard to outperform Bitcoin, Ethereum or an index unless you’re an active researcher in the space.”
Leinweber proposes a multi-token fund that replicates a market cap-weighted index to ensure you get the crypto market’s returns.
“You implicitly buy the winners and sell the losers,” he says, while the asset manager does the work for you and replicates the index.
Some crypto ETFs invest in listed companies engaged in the crypto industry, such as the crypto exchange Coinbase, the crypto bank Silvergate Bank and the Bitcoin mining company Riot Blockchain, instead of buying the cryptocurrencies directly.
Investment companies also offer separately managed accounts (SMAs), which are like personal 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,” says Edelman. The challenge with SMAs is that they usually have an investment minimum of INR 1,000.
The composition of a good crypto portfolio
Stillman says 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 whitepapers about them to better understand how they work and their goals,” she says. “Dig into who’s behind them and know their track record.”
An important question is why you are buying crypto and your plans. Are you buying because your friends asked you to? Is it for short or long term gain? What do you plan to do with any winnings you make? “Some cryptos are liquid and some aren’t,” Stillman points out. “How important is it to you?”
A good crypto portfolio allows you to stick it out through bear and bull markets without losing sleep at night. “If the crypto portion of your portfolio is too large or concentrated in speculative altcoins, you risk having paper hands,” says Samsonoff.
“Conversely, if you’re too short, you risk getting greedy as confirmation bias kicks in after crypto rallies, potentially buying into a top after feeling sidelined on the way up,” he says.
How to manage your crypto portfolio
Keeping a long-term perspective, meaning years and decades, is key to managing your crypto portfolio. “This is a new and thus highly volatile asset class, and you should focus on the potential for profit over decades, not weeks or months,” says Edelman.
Leinweber says that portfolios over a four-year or longer period generally make a profit. “It’s an investment in a new technology and not a get-rich-quick scheme.”
Many experts recommend using a rupee price averaging strategy where you buy or sell a fixed amount of rupees regardless of what happens. This can take emotion out of the equation.
“Trying to time the market perfectly or check your portfolio every day generally leads to more stress and bad decisions. Instead, it’s better to have periodic reevaluations of your positions and rebalancing based on your evolving view of the market, not much different from a stock portfolio, says de Sousa.
Otherwise, the cryptocurrency allocation can overwhelm your portfolio and increase your overall risk.
“If you’re not an active trader, you should have a steady percentage to crypto and rebalance to your target weights monthly or quarterly,” says Greg King, founder and CEO of Osprey Funds.
How to track your crypto portfolio
Tracking your crypto portfolio can be a challenge.
The most important piece of advice when tracking your crypto portfolio is to adjust the time frame of your thesis, says Samsonoff. Know your trigger for entry and exit before you start.
“Without a clear plan, you will have your convictions – or lack thereof – tested and succumb to emotional decisions based on the volatility of the crypto space,” he says.
