Adding Bitcoin to your investment portfolio can have a positive impact on your long-term returns, but it’s all about timing.
A report by the CFA Institute Research Foundation examined Bitcoin’s impact on a diversified portfolio between January 2014 and September 2020. During this period, a quarterly rebalanced allocation of 2.5% to Bitcoin improved returns by a traditional portfolio by nearly 24%.
That’s a massive impact of a small allocation. This is hardly surprising: Bitcoin appreciated by around 2,875% over the period.
Be very careful with findings like this, which can make it seem like the more crypto you buy, the better. This is really only true for early adopters – for example, if you had added the same amount of crypto in December 2020, the impact through July 2022 would have been about zero.
You can get too much of a new thing, and that’s especially true of cryptocurrency. Let’s look at how much crypto you should have in your wallet.
How Much Crypto Should You Own?
Most experts agree that cryptocurrencies should not represent more than 5% of your portfolio.
This amount is “small enough to keep an investor comfortable in 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 of global expansion at Hashdex.
Some experts, like Aaron Samsonoff, chief strategy officer and co-founder of InvestDEFY, allow allocations of up to 20%. But how much crypto should be in your wallet ultimately depends on your risk tolerance and beliefs about crypto.
In addition to outsized long-term returns, cryptocurrencies tend to have excessive volatility.
In the case of the CFA Institute study, the larger the allocation to Bitcoin, the higher the return and the greater the volatility. Between January 2014 and September 2020, the traditional portfolio without Bitcoin generated a return of 6.26% compared to the traditional portfolio with a 2.5% allocation to Bitcoin, which produced an annual return of 8.6%, which also experienced increased volatility.
“The potential for outsized returns coupled with the significant risks of this emerging asset class means that a very small allocation is enough,” says 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 dramatically improve your overall returns without putting you at risk of financial harm if your cryptocurrency investment drops significantly or even drops to zero.
“Adding some to your portfolio can be a great way to really enjoy the long-term gains knowing that if you don’t go big, you’re not running out of your entire investment portfolio,” says Callie Stillman, partner at Ascenseur Financier.
What should my crypto wallet look like?
Once you have decided how much cryptocurrency to own, the question becomes which crypto assets to buy and how much to hold.
Edelman suggests four crypto wallet options. First, you can only own Bitcoin. It is the oldest and largest digital asset in the dominance of the crypto market.
“When institutions invest, they usually only buy Bitcoin. It may not produce the highest gains, but it will be the last to drop to zero,” he says.
As Bitcoin’s market dominance fades, it’s increasingly important to diversify your position to capture the full set of crypto opportunities, says Martin Leinweber, digital asset product strategist at MarketVector Indexes.
“Different assets offer notably different return patterns and respond heterogeneously to Bitcoin withdrawals,” says Leinweber. “While short-term correlations can be high, in the longer term ‘Bitcoin is nothing like a gaming token such as Axie Infinity or an exchange token such as Binance Coin (BNB).’
A popular alternative to Bitcoin is Ethereum, the second-largest cryptocurrency by market cap, with an 18% market dominance. “Many believe it has much greater utility for global trade and will therefore continue to grow in importance,” Edelman said. Many other coins and tokens are also based on the Ethereum blockchain.
You can also have a wallet that includes a mix of Bitcoin and Ethereum. “They are the Coke and Pepsi of crypto,” Edelman says. Between them, you hold over 60% of the crypto market share.
Edelman suggests a 50-50 or 60-40 split favoring your favorite coin. “Otherwise you are making a big bet”, and “bets should be avoided as this asset class is already very risky”.
While larger coins like Bitcoin and Ethereum can make up a larger share of your portfolio, holding smaller proportions of other crypto assets can improve your long-term returns, says Leinweber.
Discover Crypto ETFs
Owning crypto directly is no longer your only option for investing in the space. There are a variety of Bitcoin ETFs and blockchain ETFs that offer an easy way to gain 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 weighted by market capitalization means that Bitcoin and Ethereum make up the bulk of the fund at over 90% of the total portfolio.
“Most passive crypto investors would be better placed to focus on Bitcoin, Ethereum, and/or a crypto index fund,” says Samsonoff. “Blockchains and single-name projects, even the biggest ones, still have a lot of tail risk and on a risk-adjusted basis it’s hard to beat Bitcoin, Ethereum or an index unless you’re an active researcher in space.”
Leinweber suggests a multi-token fund that replicates a market-cap-weighted index to ensure you get the return from the crypto market.
“You implicitly buy the winners and sell the losers,” he says, with the asset manager doing the work for you and replicating the index.
Some crypto ETFs invest in publicly traded companies engaged in the crypto industry, such as crypto exchange Coinbase, crypto bank Silvergate Bank, and Bitcoin mining firm Riot Blockchain, rather than buying cryptocurrencies directly .
Investment firms also offer separately managed accounts (SMA), which are like custom mutual funds that own up to two dozen different cryptocurrencies.
“The account is run specifically for you, with a truly personalized approach to rebalancing and harvesting tax losses that you can’t do with funds,” says Edelman. The challenge for SMAs is that they usually have a minimum investment of INR 1,000.
The composition of a good crypto wallet
Stillman says your crypto portfolio should look like any other part of your investment portfolio. It should be diversified and match your risk tolerance.
You should use cryptocurrencies that you have researched and feel comfortable investing in. “Read white papers about them to better understand how they work and what they’re for,” she says. “Find out who’s behind them and know their background.”
An important question is why you buy crypto and your plans. Are you buying because your friends told you to? Is it for short or long term gain? What do you plan to do with the winnings you earn? “Some cryptos are liquid, some are not,” Stillman points out. “How important is that to you?
A good crypto wallet allows you to hold it 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,” a term used to describe investors who sell out of fear at the first sign of a downturn, Samsonoff says.
“Conversely, if you are undersized, you risk becoming greedy as confirmation bias kicks in after the crypto rally, and you potentially buy a top after feeling sidelined going up,” he said.
How to manage your crypto wallet
Keeping a long-term perspective, meaning years and decades, is key to managing your crypto portfolio. “It’s a new asset class, so very volatile, and you need to focus on the potential for earnings over decades, not weeks or months,” Edelman says.
Leinweber says portfolios over a period of four years or more are generally profitable. “It’s an investment in new technology, not a get-rich-quick scheme.”
Many experts recommend using an average rupee cost strategy where you buy or sell a fixed amount of rupees no matter what. This can take emotion out of the equation.
“Trying to time the market perfectly or checking your portfolio every day in general leads to more stress and poor decisions. Instead, it’s better to have periodic reassessments of your positions and rebalances based on of your evolving view of the market, not much different from a stock portfolio,” says de Sousa.
Otherwise, your cryptocurrency allocation could overwhelm your portfolio and increase your overall risk.
“If you’re not an active trader, you should have a consistent percentage allocation to crypto and rebalance your target weights monthly or quarterly,” says Greg King, Founder and CEO of Osprey Funds.
How to Track Your Crypto Portfolio
Keeping track of your crypto wallet can be a challenge.
The most important tip when tracking your crypto portfolio is to align your dissertation timeline, says Samsonoff. Know your entry and exit trigger before you begin.
“Without a clear plan, you will have your conviction – or lack thereof – tested and succumb to emotional decisions based on the volatility of the crypto space,” he says.