Mike Winters* explains exactly how much crypto belongs in peoples’ investment portfolios.
While there’s still plenty of room for debate about the long-term value of cryptocurrencies, many financial advisors now suggest including a small amount of it in your investment portfolio.
Crypto remains a highly speculative investment, but it’s commonly used as a hedge against inflation and to diversify investments away from stocks.
But what’s the right allocation of crypto in your portfolio? The commonly recommended range seems to be anywhere from 1-5 per cent of your total investments, provided you’d still be comfortable if you lost it all.
The case for investing 1-5 per cent of your portfolio in crypto
Cryptocurrency, if you somehow don’t know, is a digital currency secured on a decentralized network of computers, allowing for peer-to-peer transactions free from Government interference.
The long-term bet on cryptocurrency is that it’s the future of finance, and will eventually supplant traditional fiat currency.
Since these cryptocurrencies have a limited or gated supply, in theory anyone who bets correctly on crypto could see sky-high returns on their initial investment (for example, the 10,000 Bitcoins notoriously spent on two Papa Johns pizzas in 2010 would be worth A$775,929,048 today).
Similar to gold, crypto is also seen as a hedge against inflation, and as a way to diversify a portfolio away from stocks.
As Barron’s points out, from 2015 through 2020, Bitcoin’s performance was almost entirely uncorrelated to U.S. and international stocks, high-yield bonds, real estate, or gold.
For that reason, financial advisors commonly recommend an allocation of 1-5 per cent crypto in your overall investment portfolio, provided that you can afford to lose it all, given that it’s an extremely volatile investment.
“I view it as a valid asset class in a portfolio due to its lack of correlation with the traditional investments of stocks and bonds,” says Michael Kelly, a CFA at Switchback Financial, in an interview for NextAdvisor.
“Although it is high volatility, the lack of correlation [to stocks] reduces the overall portfolio volatility and provides the potential to have significant upside for returns.
“Having just a small allocation in a portfolio can have massive return potential with minimal downside risk.”
The case for 0 per cent crypto in your portfolio
While JPMorgan Chase is willing to sell cryptocurrency products, its CEO Jamie Dimon thinks Bitcoin, the most popular cryptocurrency, is “worthless.”
“No matter what anyone in the room thinks, nor what any libertarian thinks, nor what anyone thinks about it, the Government’s going to regulate it.
“They are going to regulate it for [anti-money laundering] purposes, for [Bank Secrecy Act] purposes, for tax,” said Dimon, alluding to uncertainty related to renewed interest in regulation under the Biden administration.
Aside from that, cryptocurrency being a reliable “store of value” that will replace fiat currency is hardly guaranteed.
As Eswar Prasad, a trade-policy professor at Cornell University, explains to the Wall Street Journal: “Bitcoin depends on the faith of investors and nothing more.
It could equally well go to zero tomorrow if 10 per cent of investors sold.”
It also remains to be seen which cryptocurrencies will be the “winners” in the market years from now (many people who invest in crypto are just holding onto it until it becomes more widely accepted).
And while scarcity is a selling point for a given cryptocurrency, there seems to be no scarcity in the number of cryptocurrencies you can bet on.
Assuming the average investor has little knowledge of how these currencies work, how can they predict the currencies that will thrive and find wider acceptance?
Bottom line
As with any investment, your decision to invest in crypto should be based on your risk tolerance, as discussed with an investment advisor.
Crypto introduces risk to your portfolio, but its volatility can work in your favour during the short term, too — especially for diversification purposes.
If you choose to invest in crypto, whether with a buy-and-hold strategy or for short-term trading based on price swings, do your research and develop a strong understanding of why it might made sense to invest in crypto in the first place.
*Mike Winters is a contributor at Lifehacker.
This article first appeared at lifehacker.com.au.
