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The cryptocurrency space is flooded with coins and tokens all asking for your attention as a potential investment. As an investor, determining which assets to include in your portfolio will be difficult. While it is subjective and varies depending on an individual’s risk appetite and financial needs, you can always establish a balance to protect your investments while maximizing long-term returns. Over the last decade, astute investors have gained a greater understanding of the revolutionary ideas and technologies that underpin Bitcoin. It’s reminiscent of the early days of the internet in the 1990s. We all knew the internet would have a significant impact on how we live, but it was difficult to foresee how our lives would change and which new companies would drive that transformation at the time. Advisors have been dismissive of cryptocurrency since its inception in 2009. And it’s understandable: Due to legal constraints, advisors can’t simply log on to Kraken, Gemini, or Coinbase and add a small amount of cryptocurrency to their client’s portfolios, some of which they’ve been managing for decades.
Advisors Idea of a Perfect Portfolio
Advisors’ ideas about good portfolio management, according to Ric Edelman, founder of Digital Assets Council of Financial Professionals (DACFP), are based on modern portfolio theory. This concept was shaped by Nobel Prize-winning economists such as Harry Markowitz, William Sharpe, and Eugene Fama. If you’re not going to make a meaningful allocation in your portfolio, you shouldn’t make one at all, according to behavioral finance theory. Edelman explains:
“Advisors have very successful practices and they’re managing a lot of money. They’re managing hundreds of millions of dollars, often billions of dollars – and they are doing very well. No financial advisor would ever say to a client, ‘Buy one share of Microsoft.’ What’s the point? If you’re not going to make a meaningful allocation, it’s not going to move the needle.”
According to Yale research published in 2019, 4% to 6% of a portfolio’s value should be allocated to cryptocurrency. The research included all cryptos, with a focus on Bitcoin, XRP, and ether. Financial counselors, professional financial planners, and other money experts are increasingly banding together to advocate a crypto asset allocation of 1% to 5%. In addition, the Brazilian city of Rio de Janeiro this month invested 1% of its treasury reserves in cryptocurrency, which will serve as an important case study on a municipal level. According to Edelman, a one % allocation is a magical sweet spot. It’s modest enough that a market fall would be nearly imperceptible, but it still exposes regular investors to potentially quadruple the rewards they’d get otherwise. While the amount of institutional crypto investment appears to be reducing the likelihood of a complete collapse, consumers and advisors are naturally holding their breath. As a result, according to Edelman, 1% of a contribution is sufficient to be regarded as ‘substantial.’
Bitcoin is a Must Have
As you begin your journey into the world of cryptocurrencies, you must obtain knowledge that will enable you to construct a cryptocurrency portfolio. Bitcoin is the most popular cryptocurrency, accounting for 45% of the overall cryptocurrency market capitalization, at the time of writing. That is to say, Bitcoin’s price actions continue to have a significant impact on market direction. The easiest approach to begin a crypto portfolio is to allocate at least 60% of your holdings to Bitcoin, followed by a stake in Ethereum, the second most popular cryptocurrency. According to math, the optimal portfolio for risk-adjusted future returns is 75% Bitcoin and 25% Ethereum. After a few months of learning how the top two cryptocurrencies work, you can go on to investing in the top 20 cryptocurrencies (you listed on coinmarketcap.com). You can go outside the top 20 and invest in coins with a 10x or 20x potential over time and with confidence, though the risk is higher. This pattern was placed into a hypothetical situation using a 60/40 asset mix, which Edelman defines as ‘normal.’ Data from around the time of Bitcoin’s spectacular 2017 bull run shows a 1,500% increase in price, followed by an 84%. A portfolio without Bitcoin would return roughly 7% in a year (calculated conservatively) and 14.5 % in two years thanks to compound interest. However, if the asset allocation is changed to 59/40/1 (with a 1% addition of crypto), the prospective gains might increase to 22% in year 1 and 15.4 % in year 2 (with the 85 % decline), resulting in a net profit.
Although crypto is still a new asset class, a rising number of advisers are looking for reliable information to share with their clients. Financial advisors should be familiar with the digital asset ecosystem, and they should remember that there is often better advice to provide a crypto-curious client than simply ignoring the asset class altogether.