And its influence on portfolio returns.
What happens when you add cryptocurrency to a traditional portfolio of stocks and bonds? Depending on the allocation size, holding period, and whether or not you practice regular rebalancing, the results can be pretty remarkable.
According to the latest findings, the presence of cryptocurrency in a diversified portfolio results in 100% risk-adjusted returns during three years. Moreover, adding 2.5% crypto to a classic 60% stocks and 40% bonds portfolio crypto can boost the returns by 13.30 percentage points.
Times of Decline
Since crypto price is highly volatile, it is only fair to be concerned about allocating to crypto at the wrong time. Apparently, bad timing is not the difference-maker.
Curiously enough, even when its price declined, cryptocurrency allocations in investors’ portfolios turned out to be profitable. For instance, if you happened to add some coins to your portfolio at the end of 2017, the first impactful crypto bull market, it would be a positive contribution in two and a half years.
From 2014 till 2021, there have been four major Bitcoin price correlations featuring over a 50% drop. Although there were moments where allocating to crypto could have impacted returns negatively, the effect was still insignificant. Moreover, in each of the four cases, crypto allocations turned out to be beneficial to traditional portfolios even before the price recovery.
The reason behind this unprecedented dynamic is that crypto has low correlations with other assets and daily liquidity. That’s why investors get a chance to gain profits from the volatility that non-correlated investments offer.
Things to Consider
When adding crypto to your diversified portfolio, you need to consider three things: timing, rebalancing tactics, and the size of your allocation.
Practice shows that the longer you hold your cryptocurrency assets, the higher the returns. To be precise, when the holding period exceeds two years, it improves the portfolio’s cumulative and annualized returns in 100% of cases.
Highly volatile assets in one’s portfolio call for regular rebalancing. Rebalancing suggests selling some of the outperforming assets and buying a few of those that have underperformed. Suppose you continuously return an asset to a specific allocation, for instance, 2.5% to Ethereum. In that case, you will be able to add value to your portfolio and reduce the risk of an asset’s unfavourably large weight.
Should you decide to add a crypto allocation to your regular 60/40, make sure to plan out quarterly rebalancing strategies. Sticking to 4 annual asset weights adjustments will help balance crypto’s asymmetric upside returns and control inevitable drawdowns.
The study shows that adding from 1% to 2.5% BTC to a classic portfolio is likely to increase annual returns by a few percent, and you won’t have to deal with substantial volatility or drawdowns increase. In fact, you can add up to 5% without any of these issues. However, an allocation of over 5% will result in overwhelming volatility and drawdown statistics.
The Bottom Line
No one can be absolutely certain that cryptocurrency allocation and the key portfolio performance metrics will continue moving ahead. However, it is safe to say that so far, digital currencies have proved to be a positive addition to traditional portfolios.
At the same time, investors have to remember that cryptocurrency is a relatively new asset class. It cannot boast years of data analysis that will allow drawing solid conclusions. Bitcoin has been around for a little over a decade and hasn’t been tested in different environments. Every investment is a risk, and no profit is ensured.