Bitcoin is a no-Brainer Allocation | Get off zero!

I’m often asked, “how much crypto should I hold?” Difficult question to answer. It depends on your conviction in the asset class. One thing is clear in my mind, if you have any interest in managing your personal finances and aren’t living pay-check to pay-check, your allocation should be greater than 1%. In this article I paint a few portfolio scenarios with basic global and South African investment portfolios. Bitcoin’s uncorrelated return stream implies that holdings should be at least 1% of net worth, even if you don’t really “get it”.                [8-minute read]

Investment suitability matters

One of the most valuable learnings from CFA3 (I wish I’d learnt more!) is that a good investment for one person, isn’t necessarily a good investment for another. Suitability matters! If you purchase an investment that’s too volatile for you, you might sell it at the wrong time. If the investment requires too much due diligence, you might lose interest. If the time horizons are misaligned, you could end up in disaster. Imagine a retiree who is drawing income to pay living expenses but is fully invested into bitcoin, a 50% drop could ruin this retiree and cause serious psychological damage. That’s an undesirable situation.

Personal money management isn’t for everyone

Investing into bitcoin usually involves personal money management. Most people aren’t accustomed to personal money management and tend to delegate responsibility to investment managers. Investment managers have traditional mindsets and usually don’t appreciate the bitcoin’s value, which implies that they are unlikely to add bitcoin to your investment portfolios. So, if you want exposure, you probably need to take matters into your own hands.

Personal money management of small portions of your portfolio is not necessarily difficult, but there are reasons why professionals hone their craft for years. Money management presents challenges, particularly psychological challenges when investing in volatile asset classes.

One moment bitcoin is up 25% in a month – you feel like a hero and you want to double your position; the next month its down 25% – you feel like an idiot and you want to sell everything you’ve got. Obviously, this strategy isn’t profitable.

Uncorrelated returns add value in a portfolio context

An important step to a successful bitcoin investment is the decision to view it as part of your holistic investment portfolio. Bitcoin is an alternative monetary system, a hedge against extreme monetary debasement by central banks and fiscal authorities. Apart from gold, this is a completely different return driver to most other holdings in a standard investment portfolio. And that is the reason we call bitcoin an alternative or uncorrelated source of return. It makes sense to view bitcoin as a portfolio diversifier and assess bitcoin’s performance within the context of your total portfolio holdings, not gaze at the daily price changes on your favourite crypto app.

Viewing bitcoin as a portion of your total portfolio is a lot more difficult than you think! But if you can make this shift, you have a greater chance of contending with the volatility.

1% could have added 2.3% p.a. since 2010

With this vision in mind, bitcoin would have added a huge value to traditional investment portfolios over the past 10 years. Taking a traditional 60/40 MSCI World (equity)/Barclays Aggregate (bonds) I’ve added 1%, 5% and 10% allocations to this basic portfolio (reallocating the rest of the portfolio proportionately to equity and bonds with monthly re-balancing). Before looking at the numbers, “past returns do not imply future returns.” Backward looking data analysis creates context. The future may be similar to the past, but it will never look the same. I’m bullish on this asset class, but critique my research, speak to your financial advisor and think for yourself.

A mere 1% allocation of bitcoin resulted in a 2.3% increase in annualised USD returns since July 2010. The standard deviation of monthly returns increased by 0.1% to 2.7%, the maximum drawdown of the portfolio over a 3-year rolling period only fell by 0.2% to -13.6% and the minimum 1-year rolling return fell by 0.2% to -7.5%. These are astounding findings! A 2.3% increase in annualised returns for a marginal deterioration in risk statistics.

Volatility and drawdowns increase the higher the bitcoin allocation, as do the historical returns. The lofty returns from the 5% and 10% BTC allocation portfolio dwarf the 1% portfolio, but don’t be fooled. A 15% drop in total net worth during 1-year with a 18% peak to trough drawdown experienced by global portfolio 4 is not for the faint hearted! Imagine you’re saving for a house and your net worth drops by 18%? Stomach churns…

Don’t scoff at scenario 2 either, just because its dwarfed by portfolios 3 & 4. Professional investment managers WISH they could add 2.3% annually to portfolio returns generated by the 1% allocation portfolio. If you don’t know much about bitcoin, are conservative and have never managed your own money before, but you’re interested in a portfolio hedge, then a 1% allocation might be adequate.

In South Africa, the numbers are similar. Here the basic portfolio I’ve used holds 45% SA equity, 25% SA bonds, 20% global equity and 10% fixed income (which approximates a reg 28 compliant pension fund portfolio). A 2.5% increase in annualised returns was possible with only 1% BTC allocation and risk stats deteriorated marginally.

Conclusion: The more you understand bitcoin, its potential, and the pernicious consequences of our current monetary system, the less you may care about volatility. If it really is the future, you may want to shift large amounts of your net worth into the bitcoin ecosystem and face up to the volatility. But not everyone is there yet, and that’s ok, we’ll get there… This article provides a simple risk adjusted assessment of global and South African portfolios. Evidence suggests that if one can view investments within a total portfolio context and one is willing to re-balance one’s portfolio periodically, a 1% allocation to bitcoin becomes a no-brainer. Get off zero and start allocating your resources towards understanding this incredible technology that may solve several societal problems (I’ve been outlining these challenges in my monthly newsletter, latest article here)


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