How Much Crypto Should Be in Your Investment Portfolio?

[ad_1]

Estimating future returns is trickier. Investors can rely on historical averages there, too, and many do. But while multiyear returns often approximate their historical average, they occasionally vary from it by wide margins, usually during market extremes.

Story continues below advertisement

One way to handle those extremes is to deconstruct the drivers of returns. For example, most of the payoff from bonds comes from their yield, and bond yields in the US are at historic lows. So while long-term government bonds have returned about 6% a year over the past 100 years, the current yield on 30-year Treasuries of just 2.4% signals that returns are likely to be a lot lower going forward.

Stocks are a bit more involved, but the idea is the same. US stocks have returned about 9% a year over the past 150 years, broken down into 2% inflation, 2% real (net of inflation) earnings growth, 4.5% dividend yield and 0.5% valuation expansion. Looking ahead, the bond market expects inflation of 2.5% a year over the next 10 years; real earnings growth might be closer to 2.5% if US companies can maintain their recent pace; the dividend yield for the S&P 500 Index is about 1.5%; and with the stock market at or near record high valuation, further expansion is probably a stretch. That adds up to an expected return of 6.5% a year from US stocks.

Sure, estimating future returns involves judgment, and investors often disagree on the numbers. But none of that analysis is even possible with cryptocurrencies. Bitcoin, the oldest of them, has been around for only 13 years, so the record isn’t long enough to rely on. And it almost certainly isn’t indicative of the future. Bitcoin has returned about 220% a year during its short life, which is obviously unsustainable. Its annualized standard deviation has been 200% over the same time, making its volatility about 15 times that of the S&P 500 and more than 60 times that of bonds. As cryptocurrencies become more established, their returns and volatility are likely to drop significantly.

Story continues below advertisement

How much is impossible to say because no one knows what drives cryptocurrency prices, and the answer may not be coming soon. Investors have long struggled to peg expected returns for fiat currencies and commodities such as oil, grains and metals, which, like cryptocurrencies, don’t generate interest, earnings or dividends that can be separated from their price. BlackRock Inc., the world’s biggest money manager, publishes expected returns for 24 different investments, including stocks, bonds, hedge funds and private equity. It’s probably not a coincidence that currencies and commodities are not among them.

With little history and even less insight about what moves cryptocurrencies, investors are left guessing what to expect — and how to blend cryptos with other investments in their portfolios. Search Google for an answer about how much to allocate to cryptocurrencies and you’ll get a wide variety of results. One “expert” recommends that investors allocate 2% to 5% of their net worth, while another in the same article guarantees no more than 1%. In another article, a financial planner says investors can allocate as much as 10% of their risky investments to cryptocurrencies, and possibly more for younger investors.

There’s little harm in allocating a small percentage to cryptocurrencies if investors can stick with it. But hanging on may not be easy. While some data suggests that Bitcoin investors have skillfully navigated its gut-wrenching volatility, there’s more evidence showing that the more volatile an investment, the more investors tend to buy high and sell low. And nothing is more volatile than cryptocurrencies, which is all the harder to manage when investors can’t see what lies ahead.

Story continues below advertisement

Investors may have more visibility around cryptocurrencies in the years ahead, and perhaps it will shed light on longstanding questions about fiat currencies and commodities. But for now, how much to invest in cryptocurrencies remains a question of faith more than science.

More From Other Writers at Bloomberg Opinion:

• High-Yield Crypto Accounts Put Investors at Risk: Tae Kim

• Matt Levine’s Money Stuff: You Get the Crypto Rules You Pay For

• Crypto’s Cold Winter Belies a Red-Hot Future: Niall Ferguson

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Nir Kaissar is a Bloomberg Opinion columnist covering the markets. He is the founder of Unison Advisors, an asset management firm. He has worked as a lawyer at Sullivan & Cromwell and a consultant at Ernst & Young.

[ad_2]