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Given that Bitcoin (BTC 0. 48%) hit new all-time highs and crossed the $100,000 value point in December, it’s perhaps not surprising that many investors are exploring the pros and cons of adding this cryptocurrency to their portfolios. But how much of your portfolio do you allocate to Bitcoin?
The percentage might be lower than you think. According to BlackRock (BLK 0.93%), the $11.5 trillion asset management firm behind the most popular spot Bitcoin ETF (the iShares Bitcoin Trust), the optimal allocation for most investors is still just 2%.
BlackRock started by considering a typical 60/40 portfolio (60% stocks, 40% bonds). He then modeled the effect of adding progressively larger amounts of Bitcoin to this wallet, to see how it replaced his overall risk-reward profile. . BlackRock considered three conceivable allocations for Bitcoin: 1%, 2%, and 4%.
If you allocate 1% of your portfolio to Bitcoin, you will gain advantages from overall portfolio diversification. However, the positive outlook is arguably not enough to justify adding Bitcoin to its portfolio, given the inherent threat and volatility of cryptocurrencies.
If you allocate 4% of your portfolio to Bitcoin, the overall threat to your portfolio particularly increases and you start to become overleveraged through cryptocurrencies. In other words, your stocks may do well, but a bad year for Bitcoin can also ruin everything.
According to Blackrock, a 2% allocation offers the more productive of both worlds: it provides enough diversification to reduce your overall threat profile, and it also offers enough growth prospects to justify adding it to your portfolio. With a 2% allocation, BlackRock says, you’re necessarily taking on the same level of threat as if you were investing in a “Magnificent Seven” tech stock, with a higher return prospect.
As BlackRock points out, those higher returns are possible because of Bitcoin’s growing global adoption. The more that Bitcoin tips into the mainstream, the higher its price should go. That’s because the total lifetime supply of Bitcoin is capped at 21 million coins, and nearly 20 million coins are already in circulation. Any increase in global adoption should send Bitcoin demand soaring. Rising demand, combined with a fixed supply, should send the price of Bitcoin higher as well.
At this point, you might be scratching your head. A 2% allocation to Bitcoin sounds rather low, considering that some crypto investors — such as Bitcoin evangelist Michael Saylor of MicroStrategy — are advocating that you go all-in on Bitcoin. And, earlier this year, Cathie Wood of Ark Invest concluded that the optimal allocation for Bitcoin was 19.4%.
So, what does that contribute? The optimal allocation of Bitcoin is up to you. And how positive are you about Bitcoin’s long-term expansion prospects?
If you believe that Bitcoin will eventually update the U. S. dollar and the maximum vital asset in the world, as Saylor does, then you possibly need to increase your allocation. You can also be encouraged to increase your Bitcoin allocation if you believe Bitcoin has a good chance of outperforming tech stocks in the long run, as Wood does.
If, on the other hand, you think that Bitcoin is still too risky and volatile, then you might want to dial back your allocation to 1% or lower.
In my view, BlackRock’s 2% allocation is Goldilocks: not too small, not too big. You’re necessarily taking the same threat point as if you were making an investment in a Magnificent Seven tech stock, but with the prospect of even richer rewards. For investors with a 60/40 portfolio, this technique makes a lot of sense. This might be less moderate if you have a more threatening portfolio (for example, an 80/20 portfolio).
As BlackRock noted in its report, investors deserve to consider the potential effect of a Trump presidency when making projections about Bitcoin’s long-term bullish prospects: “The rise to all-time highs after the recent U. S. election reflects investors’ growing chances to make money. “greater adoption given President-elect Donald Trump’s statements and staff decisions in favor of cryptocurrencies.
So keep your eyes on what’s happening in Washington, D.C. If the Trump White House follows through on pro-Bitcoin promises made on the campaign trail — such as the creation of a strategic Bitcoin reserve — then the rate of global Bitcoin adoption might skyrocket over the next four years. And that, in turn, could lead to an entirely new evaluation of what the optimal Bitcoin allocation should be.
Dominic Basulto has positions in Bitcoin. The Motley Fool holds positions and recommends Bitcoin. The Motley Fool has a disclosure policy.
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