Does Bitcoin belong in your retirement portfolio?
After US lawmakers reintroduced the Financial Freedom Act in mid-February, there is renewed debate about what role crypto should play in retirement plans. The goal of the Financial Freedom Act is simple: Let Americans invest their retirement savings however they want, even if that means investing in crypto.
There’s just one problem with it. Right now, the official guidance from the US Department of Labor is that employers should not offer crypto options in their 401(k) plans. In early February, moreover, a trio of regulators – the SEC, the North American Securities Administrators Association and the Financial Industry Regulatory Authority – warned against crypto exposure in self-directed individual retirement accounts (IRAs). With that in mind, here’s a closer look at the pros and cons of adding cryptocurrencies such as Bitcoin (BTC -1.77%) to your pension portfolio.
Benefits of Adding Crypto to Your Retirement Portfolio
The overwhelming benefit of adding crypto to a retirement portfolio is the potential for truly life-changing gains. For example, in the period from 2011 to 2021, Bitcoin was the best asset class in the world, and it wasn’t even close. During this time period, Bitcoin delivered annual returns of 230% to investors. In comparison, the next best asset class (major technology stocks) returned just 20% on an annualized basis.
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If you’re behind on your retirement savings, or if you’re planning to retire early, it’s easy to see the appeal of investing in crypto. Instead of investing for 30 years in a relatively safe asset class and methodically cashing out returns to save for retirement, Bitcoin theoretically allows you to invest for perhaps 10 years and have a large enough nest egg to settle down and retire comfortably .
Disadvantages of Adding Crypto to Your Retirement Portfolio
Of course, this kind of thinking presupposes two key things. One, it assumes that past returns are a reliable predictor of future returns. But that’s not necessarily the case with crypto, which has a relatively short track record. Sure, Bitcoin may have a track record of nearly 15 years, but newer altcoins come and go. Also, we don’t really know how Bitcoin is going to perform in the future.
Second, by putting a significant portion of your retirement funds into crypto, you ignore the fact that the crypto market is extremely volatile. Just when you think you’ve reached your retirement goals, your precious nest egg can be taken away from you.
The last two years are a good example of this volatility in the job. After a banner year in 2021, when just about every crypto neared all-time highs, the crypto market suffered through a rough house in 2022. Almost every major crypto – even Bitcoin – fell by 65% or more last year. That means your retirement savings would be largely wiped out if you were counting on crypto to fund your retirement.
Another major disadvantage of adding Bitcoin to your retirement portfolio is that there are few formal options available from top financial institutions. As long as the US Department of Labor refuses to give a stamp of approval to crypto for 401(k) plans, employers are going to be very leery of offering these plans. They have a fiduciary duty to protect their employees, and right now crypto is not seen as a responsible way to exercise that fiduciary duty.
As a result, individual investors are left with a DIY approach. In practical terms, this means opening an account with a major cryptocurrency exchange and designating all funds in that account for retirement. But what happens if that cryptocurrency exchange turns out to be the next one FTX (FTT -0.36%) and fail? Or what if you invest in many speculative altcoins instead of more reliable names like Bitcoin because you don’t have access to professional investment advice?
Shifting sentiments in Washington?
Based on the above, it is easy to see why there is such a controversial debate going on right now around the topic of crypto in retirement accounts. On one side you have free market advocates, who believe the government should stay out of the game and the free market should decide what happens next. They point to examples such as Fidelity Investments, which led the way in April 2022 with the introduction of crypto pension schemes for employers.
On the other hand, you have the proponents of government intervention, who believe the government has an important role to play in protecting individual investors from losing their nest eggs. They point to examples like the recent meltdown of FTX as evidence that investing in crypto is fraught with danger.
The 5% rule
Keep an eye on this space. Things could change soon if the Financial Freedom Act is finally passed. For now, a good rule of thumb is that for DIY investors, the maximum amount of retirement savings that should be allocated to crypto is 5%. This is the cap currently suggested by many financial advisors, and it ensures that the overwhelming majority of your retirement portfolio is tied up in less risky and less speculative assets. Thus, even if Bitcoin goes to $0, you will not face a complete wipeout of your retirement portfolio.
