The adoption of cryptocurrencies is increasing. As a result, many wonder if they should include crypto in their investment portfolios. Find out exactly how much the next challenge is.
Increased adoption by companies like PayPal, investment from institutions like Rothschild Investments, and the recent listing of Coinbase make it harder to deny that cryptocurrencies are becoming a common feature not just in the world but in a portfolio. complete investment.
There are several that suggest different allocations based on the typical 60/40 ratio stock / bond portfolio. However, when using the Black-Litterman model, Investors can assign the amount of cryptocurrencies they have according to their confidence in its growth potential.
Institutional Investor Interest in Bitcoin
Just two years ago, famous Shark Tank investor Kevin O’Leary called Bitcoin (BTC) “junk.” Last year, he released a video titled, “Why am I not investing in Bitcoin!”
However, since the total market capitalization of cryptocurrencies recently surpassed $ 2 trillion, it is almost impossible for institutional investors to ignore it.
Even O’Leary has changed his mind. Last month, the famous investor announced that he would allocate 3% of his portfolio to Bitcoin. For someone with a net worth of $ 400 million, This allocation amounts to $ 12 million in BTC.
Other companies have been setting a similar example for the past year. In August 2020, MicroStrategy invested $ 250 million in Bitcoin. Since then, has invested a total of 2,226 billion dollars in BTC.
Payment service Square Inc. followed suit in October 2020, investing $ 50 million in BTC. He recently increased this by another $ 170 million. Finally, Tesla caused quite a stir in February 2021, investing $ 1.5 billion in the cryptocurrency.
As with all investments, the greatest interest from these big players trickles down to smaller-scale investors who are interested in making smart portfolio moves.
Understanding Bitcoin for your investment portfolio
Investors who want to figure out how to invest in cryptocurrencies must first understand them.
Investment firms are beginning to offer explanations to potential clients. For example, Fidelity Investments published the report “Understanding Bitcoin.”
In the report, Fidelity’s director of global macro, Jurrien Timmer, outlines the growth potential of Bitcoin and compares it to other assets to help investors better understand it.
An exponential growth potential
Timmer claims that an increasing number of investors and portfolio managers consider Bitcoin to be a legitimate and distinct asset class.
Bitcoin, he explains, is a finite asset with a unique supply and a unique demand dimension. However, its distributed nature allows for a network effect, which is not the case with other assets.
Specifically, Timmer refers to Metcalfe’s Law. Essentially, Metcalfe’s law says that as the number of its users grows linearly, the value of a network grows geometrically.
Bitcoin bullish bull
In other words, Bitcoin’s utility, in this case, value, should grow much faster than its network of participants.
Timmer points out that Bitcoin’s growth curve appears to still be in its early, exponential phase, and could remain that way for several years. This indicates a bullish case for Bitcoin.
As your demand could grow exponentially, his offer remains fixed at a total of 21 million.
Digital gold vs physical gold
Timmer then points out that some see Bitcoin as a form of “digital gold.” This is because Bitcoin could act as a stable store of value, potentially offering protection against inflation.
In this era, where the economic stimulus against the coronavirus has seen governments around the world printing money at an unprecedented rate, Bitcoin may be stealing the limelight from gold when it comes to hedging against inflation.
In addition to being easier to transfer and maintain, Timmer notes that Bitcoin has a unique advantage over gold: its finite supply. “Gold is scarce, but not increasingly scarce,” it says in the report.
Timmer concludes with several suggestions. First, it says that some investors they may want to consider Bitcoin as a component on the bond side of a 60/40 stock / bond portfolio.
Since bond yields are close to zero or negative, he suggests replacing some of them with gold or “assets that behave like gold.”
He notes that Bitcoin has several risks, including volatility, competition, and policy intervention. However, it also admits that:
“Bitcoin is a legitimate store of value, it is scarcer than gold and is complemented by potentially exponential demand dynamics.”
As the report suggests, the question now shifts from whether you should invest in Bitcoin to how much.
Bitcoin versus Gold
Various Cryptocurrency Allocation Suggestions
Other financial experts have also made portfolio allocation suggestions based on the 60/40 model.
Ark Invest CEO Cathie Wood said she believes that Bitcoin and other cryptocurrencies can become a standard part of recommended wallets for investors.
She posited that cryptocurrencies, like Bitcoin, will eventually resemble bonds. In consecuense, believes that the bond portions of these portfolio allocations may finally give way to cryptocurrencies.
“You think about the traditional 60/40 stock bond portfolio, but look at what’s happening with bonds right now. […] If we’re going to end a 40-year secular drop in interest rates, that asset class has done its thing. Whats Next? We believe that cryptocurrencies could be the solution ”.
Another allocation suggestion comes from a study by Yale economist Aleh Tsyvinski.
According to the study, cryptocurrencies enjoy higher potential returns than other types of assets, despite their higher volatility. A portfolio must contain 6% BTC to achieve optimal build, says the study.
Even for Bitcoin skeptics, the research suggests at least a 4% Bitcoin allocation. Even just for the purpose of diversifying, Those who are cautious with cryptocurrencies should have at least 1% in their portfolio.
Ric Edelman, founder of Edelman Financial Engines, suggests this conservative amount. Replacing one percentage point of the 60% equity allocation with cryptocurrencies would give investors the benefit of diversification without risking their portfolio:
“We need to recognize that the 1% allocation will not materially harm a customer. […] It will not prevent them from reaching their financial goals and it will not hurt their personal finances. “
Edelman praises the virtual currency for its diversification, as they have little correlation with other asset classes.
The Black-Litterman Model
Although experts have various opinions on how much Bitcoin to have in your portfolio, how can an average retail investor decide?
Fortunately, there is a model that takes an objective approach and at the same time includes investor preferences.
The Black-Litterman model begins with a neutral “balance” portfolio. It then provides a formula for increasing holdings based on the investor’s world view.
It incorporates not only an investor’s growth estimate, but also confidence in that estimate. These inputs are translated into a specific portfolio allocation.
It starts with the global market portfolio, or all the world’s asset holdings, as a neutral starting point. If bonds occupy 51.98% of the total asset market, stocks 47.03% and cryptocurrencies at $ 2 trillion, 0.99%, then the base portfolio should have a similar allocation.
Next, for any given growth rate in cryptocurrencies, the Black-Litterman model returns the amount that an investor should have in their portfolio. Later, the investor can specify his level of conviction in that assumed growth rate, and the model is adjusted accordingly.
As cryptocurrencies increasingly overshadow investors’ interests in other assets, apparently The Black-Litterman model is worth considering among the many tools for optimally determining your crypto investment.
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