How a lot of my portfolio ought to Bitcoin be allotted?

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When people first step into Bitcoin as a savings tool, or when traditional financiers view it as a potential investment, they are quickly faced with the size issue. How much of my wealth should I invest in this new and promising asset class?

For most Maxis, this question is ridiculous: as much as humanly (or reasonably) possible, of course. Die-hard maxis borrow Fiat to get more sats – Pierre Rochard’s speculative attack. If you hold an asset other than BTC, you are effectively closing out Bitcoin; You don’t want to short bitcoin.

If we step into the role of risk / diversification strategies for a moment, less convinced – and risk averse – fund managers or ordinary people, Bitcoin is just a matter of judiciously sizing. If you can’t stand 100% and 0% is too low – what is a reasonable percentage?

Earlier this summer, Paul Tudor Jones described what he wanted with “Bitcoin as a portfolio diversifier” – “The only thing I know for sure, I want 5% in gold, 5% in Bitcoin, 5% in cash, 5% in commodities. “

Between 1% and 5% is a common allotment suggestion, even among “crypto-curious” people – mostly, I suspect, because 5% is a nice, simple number (e.g. few people will want a 7.648% allotment). Other recommendations range from low single digit percentages to over 10%. Single-digit allocations are not uncommon: even some high profile university foundations seem to have something like this.

Of course, with things moving fast in this area, you also need a rule as to when and by how much to realign your portfolio if you are going for a stake. If you keep switching your Bitcoin holdings into other assets when and when Bitcoin appreciates, you will be missing out on much of this potential uptrend – and could lose an unacceptable amount in tax liabilities and trading fees. This is usually fine if you’re just looking for a little extra return on top of an otherwise traditional investment thesis, but pretty disastrous if Bitcoin actually repeats its tendencies to multiply its value by ten times. In these cases, your meager extra return will look like the people who bought cars or yachts for Bitcoin in 2013: terribly expensive.

The economists Yukun Liu and Aleh Tsyvinski from Yale and Rochester Universities, respectively, came to the conclusion in a three-year-old paper that a Bitcoin exposure of between 1% and 6% is the optimal size, depending on how high your future annual budget is Excess returns forecast (30, 50, 100 and 200%, respectively). Those numbers are old now, and we have had widespread retail and institutional acceptance since then, which has apparently increased the correlation with the overall market. Presumably, as I have argued elsewhere, the return profile must also fall. According to Liu and Tsyvinski, these two factors should reduce the optimal bitcoin allocation in a portfolio. William Baldwin of Forbes correctly writes, in my opinion, that

“… the history of Bitcoin is short. It’s one thing to look back at a hundred year history of stocks and bonds and draw conclusions about how much return and how much volatility to expect from them. It is quite a different matter to extrapolate something from the crazy first decade of a virtual object. “

Bloomberg’s Joe Weisenthal frequently points out that Bitcoin is eerily correlated to other high-risk assets:

“One of Bitcoin’s big selling points is its diversification benefits, but these days it’s almost tick-by-tick just your standard risk asset. It could be a cloud stock or Tesla. Or the hell, even gold. ”

And Amy Arnott for Morningstar, who shows BTC’s relationship to other assets is changing:

“As mainstream investors increasingly embrace Bitcoin, its value as a diversification tool is diminishing. Hence, there is no guarantee that adding Bitcoin will improve a portfolio’s risk-adjusted returns, especially to the same extent as it has in the past. “

Bitcoin does not actually trade with future-oriented inflation expectations, but is much more susceptible to real interest rates, of which inflation is only a part – apart from certain events such as the fear of China miners or the tweets from Elon Musk anyway. In this way, it shares a relationship with gold, whose greatest disadvantage as a financial asset is its opportunity cost in a high yield environment. If you don’t think this will come back, stacking sats is a pretty safe investment option.

The solid investment advice not to put all your eggs in one basket has its academic-financial version in diversification. That doesn’t just mean holding stocks of a few different companies when all of those companies are exposed to the same risks or trading more or less identically with one another – and as central banks run their money printers, things are slowly becoming the same trade. The theoretical point of what’s called modern portfolio theory is that different segments of your portfolio compensate for other segments, so random shocks, good or bad, will result in most of your nest egg remaining intact no matter what. You want uncorrelated (or negatively correlated) assets so that you can keep your savings in case of an emergency or one-off occurrence.

For a long-term investor who manages their own assets (or perhaps those of a household) and plans over decades, this may not be as critical. The advice to ordinary people to put the average dollar cost in passive mutual funds or the like is exactly this: you won’t be using the funds in the next 5, 10, or 20 years, so the value of smoother portfolio performance makes little sense to you. What you want are returns over decades – in practice up to retirement. Even taking into account the incessant complaints from the financial media about price volatility seems to keep the financial health of this asset very marginal. Bitcoin’s Sharpe Ratio, which is its rate of return relative to its volatility, routinely outperforms most other assets:

“Risk-adjusted returns are calculated using the Sharpe ratio over a 4-year HODL period,” courtesy of Willy Woo

That said, even if you ignore its obscure early days, a couple of years of HODLing Bitcoin has paid more than enough for its short-term price risks.

How can you understand all of this?

It is important to remember that all of these rules are general and are not tailored to your financial situation. In fairness, responsible financial advisors cannot publicly give much more specific information in interviews that have been read millions of times, ie speak about the financial situation of which they know very little. Making sweeping statements about 2% or 5% or 10% of your savings is completely detached from three crucial elements of your life:

  • Timing: When will you use or need the funds? Will you retire at 40? Or will you retire at a more regular retirement age? Are you acquiring an untouched, infinitely long fortune that you can pass on to your heirs?
  • Risk Tolerance: How comfortable do you feel about investments rising and falling in value over short or medium periods of time? If you cannot sleep at night because the price of an asset is moving, it is a clear sign that you are overexposed. Some people are blasé and pile up untouched by 50% + drawdowns; others are jumpy like scared cats. Determine your positions accordingly.
  • Income security: Other financial obligations are important, such as “How much do you make?” “How much does your spouse make?” “What are your expenses?” Unless you think of BTC as a game of chance against a seemingly overwhelming world (in which case, I advise you, metaphorically speaking, to get your house in order first), I wouldn’t advise anyone who doesn’t carry Bitcoin with their lunch or rental money. Do not max your second credit card to use Bitcoin if it means your family or children will not be able to eat.

These criteria will look different for all of us, and the knowledge and understanding of how Bitcoin works – and how the established monetary and financial system surrounds all of these criteria. In general, the deeper you go down the rabbit hole, the more convinced you are of Bitcoin’s long-term price potential and the more comfortable you feel with a higher proportion of assets allocated.

The assignment problem is much more complicated than a single number. In the borderline case, you may not even see BTC as part of the rest of your investment portfolio, but rather as a free-floating independent asset that you have absolute ownership of.

This is a guest post by Joakim Book. The opinions expressed are solely their own and do not necessarily reflect those of BTC Inc or Bitcoin Magazine.


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