Do cryptocurrency assets belong in a conservative investment portfolio?
Loyalty investments he believes it. They recently incorporated their bitcoin spot ETF into their Conservative All-in-One portfolio. However, a financial institution has many different priorities than the average investor, whose goals focus on retirement, homeownership, education and other financial life expenses. For the rest of us, where does an extremely volatile, low-correlation asset like cryptocurrency fit into a conservative investment strategy?
I think Fidelity’s Conservative All-in-One fund example is actually a useful blueprint for a personal project, conservative investment strategy. Their 1%-3% cryptocurrency allocation into an otherwise low-cost, low-risk asset fund is a far cry from the full-steam FOMO investing we see from eager retail investors.
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Adding to this trend, too Black rock announced its decision to include Spot bitcoin ETF in its popular Global Allocation Fund (MALOX) for retail investors, highlighting a growing acceptance of cryptocurrencies as a viable component of conservative investment portfolios.
What not to do when investing in cryptocurrencies
The typical cryptocurrency hype cycle looks like this: Bitcoin or a similar fund experiences rapid growth. People don’t want to miss out on anything, so they buy right when the asset is most expensive, only to suffer when the price swings lower.
Or they look at the current value of a bitcoin and decide that it is too expensive, without realizing that it is possible to buy less than one bitcoin. So they look for a cheaper crypto asset in an absolute sense. They overallocate to compensate for the perceived loss resulting from market devaluation. This is also not a behavior exclusive to cryptocurrencies. Tech investors may feel like they’ve missed the boat Nvidiabut the cost of purchasing Nvidia (NVDA) is too high, so they look for an “Nvidia-like” stock to overinvest in, hoping it benefits from the same forces that lifted Nvidia.
In short, you can’t chase cryptocurrency hype without defeating the entire purpose of a conservative investment strategy.
That said, at first glance it may seem counterintuitive to include any amount of cryptocurrency in a conservative portfolio. What motivated Fidelity to maintain a 3% bitcoin allocation alongside a package of Canadian government bonds?
The difference between risk and volatility
It makes perfect sense when you realize that risk is not the same thing as volatility. Traditional measures of volatility may not fully capture the risk and opportunities in the cryptocurrency market. Because these measures often treat volatility as downside risk, they may not accurately reflect the potential for significant gains in rising markets.
This peculiarity makes cryptocurrencies a challenging asset class to evaluate using conventional risk parameters alone. Bitcoin is the textbook definition of a volatile asset. Over the course of its existence, it has withstood six declines of more than 50%, recovering each time. But it is also an asset with a very low correlation with traditional markets.
By including investments that don’t move in lockstep with the rest of the market, investors can reduce portfolio volatility. This means that when one part of the market underperforms, the impact on the overall portfolio is mitigated. In a small enough amount, a volatile asset like cryptocurrency can actually de-risk a portfolio.
How the allocation percentage was achieved
Fidelity didn’t arrive at the 3% allocation by accident. We reached a similar conclusion after crunching the numbers to try to find the Goldilocks range for the cryptocurrency in a conservative investment strategy. We started with a 50-50 split of global bonds and stocks. We have added crypto allocations, 1% at a time, back-testing every 250 day period starting in 2015.
From 1% to 3%, we found there is virtually no difference in downside risk between a cryptocurrency-free baseline and the same portfolio with a 3% cryptocurrency allocation. But the 3% version widens the range of upside performance. Once the 7% allocation was exceeded, however, cryptocurrency volatility began to undermine the low-risk, low-cost objective of a conservative strategy.
An allocation of between 1% and 3% of bitcoin will not make you rich. But it won’t destroy you either. Resist the temptation to think of cryptocurrency as the key to instant wealth, because for most of us it is not. Consult a instead financial professional and consider cryptocurrencies as a tool to be used in a specific amount for a targeted goal.
The views and opinions expressed are those of the authors but not necessarily those of MarketVector Indexes GmbH.
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This article was written by and presents the opinions of our contributing consultant, not Kiplinger’s editorial staff. You can check advisor records with SEC or with FINRA.
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