Small bitcoin weights can have a positive impact on portfolios

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When a financial advisor discusses the appropriate asset allocation for a portfolio, they are essentially trying to build a plan that maximizes expected returns given a given level of risk.

The advisor pays less attention to the behavior of an individual security and instead focuses on how the different asset classes work together as a group.

So what is the role of bitcoin in an investment portfolio and does it make sense to integrate it?

Conventional wisdom suggests that while bitcoin has generated excellent returns, it will add substantial risk to a traditional equity / bond portfolio.

That said, it’s important to remember that many asset classes that are now common in a portfolio were at one point considered far too volatile for the average investor. We don’t hesitate to include emerging markets or tech stocks in an allocation today, and yet there was a time when experts thought they were far too risky.

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Their concerns were justified.

Since the inception in 1988 of the MSCI Emerging Markets Index, there have been seven declines of 25% or more. Additionally, Nasdaq stocks slumped 79% during the dot-com crisis, as tech companies fell at a lightning pace.

Nonetheless, they both bounced back and paid off well when included in a diversified portfolio that considered time horizon and risk tolerance.

It seems the same arguments have been made about digital assets, although a long-term study by VanEck found that bitcoin exhibited less volatility than 112 S&P 500 stocks over a 90-day period and 145 stocks. since the beginning of the year. until November 13, 2020.

This raises the question of the impact of bitcoin on a well-constructed portfolio and whether it is suitable for the average investor to have some exposure.

Many can remember the bell curve which rates the number of potential outcomes. When a portfolio is built, each additional possibility on that bell curve increases volatility. If the goal is to achieve the best returns with the least risk, adding an asset class that serves that purpose is worth considering.

Some recent industry research has revealed that small bitcoin weights have a disproportionately positive impact on risk-adjusted returns and diversification compared to other alternative assets. Additionally, research has concluded that bitcoin’s lack of correlation with other assets makes it a useful alternative asset that can actually help reduce exposure to business cycles.

At this point, the RIA Digital Asset Council reports that when investors allocate 1% to a balanced portfolio, returns rise with little to no impact on volatility or maximum losses when the market becomes risky. Likewise, rebalancing a portfolio comprising 1% bitcoin each quarter increased the long-term return of a balanced portfolio, although the volatility and maximum drawdowns for the same period barely budged.

Suffice it to say that having an open mind and using the risk management tools already at our disposal makes a lot of sense.

By Ivory Johnson, Founder of Delancey Wealth Management

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