Should your portfolio include bitcoin? Yes, but just a 2% position, sa
Anyone looking at the astronomical rise in the price of bitcoin over recent years may be wishing they had allocated a hefty portion of their money to the red-hot digital currency, so that they could now be reaping a position worth millions.
But while hindsight is 20-20, the question of whether an investor should now be including bitcoin or one of its cryptocurrency rivals into their portfolio is far less clear. While bitcoin prices BTCUSD, -0.33% have soared thus far this year—up about 500% in 2017; it recently hit a record above $6,000—it continues to be extremely volatile, and perpetually dogged by questions over whether it is in a bubble.
So with heavy uncertainty on one hand, but a stratospheric record on the other, does bitcoin belong in the average investor’s portfolio? According to one analyst, there is an argument for holding it—so long as the position is extremely small.
Nick Maggiulli, an independent researcher, said that “the optimal portfolio” should include an allocation to bitcoin, but just 2% of the portfolio.
“Bitcoin does add value to a portfolio, but only when held in small doses,” he wrote in a blog post. “A little bitcoin goes a long way.” He stressed his hypothetical portfolio was based on historical data, and that he wasn’t issuing a recommendation to buy bitcoin or any other cryptocurrency.
Maggiulli’s “optimal portfolio” has just three components. In addition to the 2% held in bitcoin, it has a 54% allocation to U.S. stocks, which he represented with the S&P 500-tracking SPDR S&P 500 ETF Trust SPY, +0.08% and a 44% position in U.S. long-term bonds, which he got exposure to with the Vanguard Long-Term Bond Index Fund VBLTX, +0.22%
The construction of the portfolio was based on asset returns over the seven-year period from September 2010 and September 2017 and sought to balance price appreciation with low volatility. While bitcoin certainly delivered on the former, Maggiulli limited its size in the portfolio due to its volatility; he called it “by far the most volatile asset class” of the major categories he considered.
“It seems to me like bitcoin’s volatility has a large negative impact on its inclusion in a portfolio,” he wrote. “Therefore, the solver optimizes to include a little bit of bitcoin for its highly positive returns, without adding much risk to the portfolio.”
According to his data, bitcoin had an average monthly return of 25% from September 2010 to September 2017, the highest of the asset classes he considered. “I understand that this is being heavily skewed by outliers, but its median monthly return is still 7% over this time period,” compared with the 1.4% median return of the S&P 500 over the same period. (Emphasis in original.) “I understand that these two returns are not necessarily comparable for a host of reasons, however, the difference is striking.”
Bitcoin’s high returns and high risk stands in contrast to gold, which offered lower returns over the past seven years, but also less risk. “Bitcoin is not the new gold,” Maggiulli wrote. “It is some other beast entirely.”
While bitcoin—along with blockchain, the underlying technology that cryptocurrencies run on—has gained increased legitimacy in recent years, Maggiulli said he would be “a fool” to speculate on where bitcoin or any of its rivals might be headed.
“Maybe it is a big bubble and I am analyzing something as useless as a tulip, or maybe this is the future of permission-less transactions that overthrows entire industries,” he wrote. “Either way, I now have some evidence that Bitcoin might be worthy for investors, though in small doses.”