Bitcoin deserves some space in your portfolio

by James · April 5, 2023

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First, Goldman Sachs Group Inc. highlighted Bitcoin as the best-performing asset in terms of absolute and risk-adjusted returns earlier this year. Then the banking crisis happened and the largest digital coin rose to its highest price in ten months. It’s enough to make even a naysayer reconsider.

But is this year’s turnaround just a short-lived bubble or proof of the what-doesn’t-kill-you-makes-you-stronger thesis? Views are everywhere. The White House recently released a financial report slamming crypto, saying the assets have no fundamental value; while Bitcoin bulls like ARK Investment Management CEO Cathie Wood see the rise as a confirmation of decentralization.

Financial advisors’ assessments of whether to invest in Bitcoin yield answers ranging from “Don’t mistake several months of positive performance for a long-term trend. (Remember Enron?)” to “It represents an opportunity to create wealth that we haven’t seen in 35 years.”

The question takes on even greater importance after the disastrous performance last year of the traditional 60/40 investment model, prompting a reassessment of the six-decade tradition of retail investors allocating 60% of their portfolios to stocks and 40% to bonds. (or some type of combination between the two).

There is no clear answer here. I’m neither a bull nor a bear when it comes to bitcoin, but it’s hard to argue with adding a small allocation as an opportunistic growth play.

Let’s take a look at the numbers. According to Morningstar Inc. calculations, an investor with a 1% allocation to Bitcoin in a traditional 60/40 portfolio (with the Bitcoin allocation subtracted from the stock bucket) would have slightly underperformed over the past year—down 8, 93% versus a drop of 8.77% for a traditional 60/40 portfolio. These numbers aren’t terrible considering that Bitcoin had a volume of close to 40% during that time period.

Over longer periods, the 1% allocation to Bitcoin would have increased returns dramatically. In the 10 years ending in March, the 1% Bitcoin portfolio beat the traditional 60/40 portfolio – 13.3% to 7.8% annually. A slightly larger allocation of 2% produced somewhat worse performance over the past year (down about 9%), but gains of nearly 18% annually over a 10-year period. Bitcoin still has a relatively low correlation with other asset classes, but that’s starting to change a bit when it comes to stocks, especially large-caps, points out Amy Arnott, a portfolio strategist at Morningstar.

Of course, you can’t base yourself on historical performance, and it’s hard to imagine Bitcoin seeing the same tenfold price increase it has experienced over the past decade. Still, it looks set to go higher, and now might be a good time to get in relatively cheap.

Bloomberg Intelligence senior macro strategist Mike McGlone says he expects it’s “only a matter of time” before Bitcoin hits $100,000 because it has something very rare — definably diminishing supply, but it’s still in the early days of adoption. “Bitcoin is well on its way to becoming global digital security in a world that is going that way,” says McGlone. “Bumps in the road are to be expected, but the overall trajectory seems quite durable.”

Goldman has also said that Bitcoin could eventually reach $100,000 if investors accept its use as “digital gold.” Bloomberg Intelligence’s Jamie Douglas Coutts, a senior market structure analyst, points out how Bitcoin just recorded its second-best first-quarter performance in a decade — a strong first quarter has typically resulted in higher year-end prices. In particular, in previous periods of financial turmoil, when a key indicator of risk to the US banking system increased, Bitcoin fell – this time, although the gauge has climbed, bitcoin has continued to rise.

All of which is to say that even the optimists will struggle to pick the best time to wade in. With exposure to Bitcoin comes volatility, which underscores how even a small allocation is really best suited to an investor with a longer horizon, who can tolerate risk; i.e. not pensioners with a fixed income. Morningstar’s calculations show that a 1% allocation introduced slightly more volatility over the past year than a straight 60/40 portfolio, but over a 10-year period volatility is almost double.

Given Bitcoin’s liquidity problems and concerns about using exchanges, retail investors who are optimistic about its growth may struggle to figure out the best way to buy it. The $14 billion Grayscale Bitcoin Trust is set up so that investors can effectively record gains or losses in Bitcoin in a brokerage account instead of actually buying Bitcoin directly on an exchange with a digital wallet. While that sounds good in theory, the trust has been trading at deep discounts to the underlying price of Bitcoin, in part due to competition. And the 2% fees are particularly high.

A better option for some investors would be if the Grayscale trust converts to an ETF, which it has tried to do. So far, their efforts have been rejected by the Securities and Exchange Commission, but if successful on appeal, an ETF structure (where shares can be created and redeemed in line with demand) is likely to track Bitcoin’s price better than a trust, which basically works as a closed fund.

Beyond shades of gray, industry-wide regulatory changes lie ahead, making investing in Bitcoin an even bumpier ride. But they could ultimately provide more security and help push the digital coin even higher. For a long-term investor, it seems worthwhile to start making small, regular allocations to Bitcoin.