If Done Right, Crypto Can Lower Risk in Your Investments

The word crypto sits on a digital block against a digital background.

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published 5 June 2024

Do cryptocurrency assets belong in a conservative investment portfolio?

Fidelity Canada believes so. They have recently incorporated their spot bitcoin 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 a wildly volatile, low-correlation asset like cryptocurrency fit into a conservative investment strategy?

I think the example of Fidelity Canada’s Conservative All-in-One fund is actually a useful blueprint for a personal, conservative investment strategy. Their allocation of 1% to 3% crypto into a fund of otherwise low-cost, low-risk assets is a far cry from the full-steam-ahead FOMO investing that we see from enthusiastic retail investors.

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Adding to this trend, even BlackRock announced its decision to include spot bitcoin ETFs in its popular Global Allocation Fund (MALOX) for retail investors, highlighting a growing acceptance of crypto assets as a viable component of conservative investment portfolios.

What not to do when investing in crypto

The typical crypto hype cycle looks like this: Bitcoin or a similar fund posts rapid growth. People don’t want to miss out, so they buy in right when the asset is most expensive, only to suffer when the price oscillates downward.

Or, they look at the current value of a bitcoin and decide it’s too pricey, not realizing it’s possible to buy less than one bitcoin. So they look for a cheaper crypto asset in an absolute sense. They overallocate to make up for the perceived loss from mistiming the market. This isn’t a behavior exclusive to crypto either. Tech sector investors may feel like they missed the boat on Nvidia’s gains but that the cost to buy into 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 after crypto hype without blowing up the entire purpose of a conservative investment strategy.

That said, it can seem counterintuitive at first glance to include any amount of cryptocurrency in a conservative portfolio. What drove Fidelity Canada to stick a 3% bitcoin allocation next to a bundle of Canadian government bonds?

The difference between risk and volatility

It makes perfect sense when you realize that risk is not the same as volatility. Traditional measures of volatility may not fully capture the risk and opportunity in the crypto market. Since these measures often consider volatility a downside risk, they might not accurately reflect the potential for significant gains in rising markets.

This peculiarity makes crypto assets a challenging asset class to evaluate through conventional risk metrics alone. Bitcoin is the textbook definition of a volatile asset. In the span of its existence, it weathered six 50%-plus drawdowns, bouncing back every time. But it is also an asset with a very low correlation to 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 is underperforming, the impact on the overall portfolio is mitigated. In a small enough quantity, a volatile asset like cryptocurrency can actually de-risk a portfolio.

How the allocation percentage was reached

Fidelity Canada did not arrive at the 3% allocation by chance. We reached a similar conclusion after we ran the numbers to try to find the Goldilocks range for cryptocurrency in a conservative investment strategy. We started with a 50-50 split of global bonds and equities. We added crypto allocations, 1% at a time, back-testing every 250-day period of performance from 2015.

At 1% to 3%, we found there is virtually no difference in downside risk between a crypto-free baseline and the same portfolio with a 3% crypto allocation. But the 3% version broadens the range of upside performance. Once we went past a 7% allocation, though, crypto’s volatility began to undermine the low-risk, low-cost goal of a conservative strategy.

A 1% to 3% allocation of bitcoin won’t make you rich. But it won’t destroy you either. Resist the temptation to think of cryptocurrency as a key to instant wealth, because for the majority of us, it’s not. Instead, consult with a financial professional and look at crypto as a tool to use in a specific amount for a focused goal.

The views and opinions expressed are those of the authors but not necessarily those of MarketVector Indexes GmbH.

Disclaimer

This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.

Martin Leinweber is a seasoned Digital Asset Product Strategist at MarketVector Indexes™, a leading European regulated index provider renowned for its groundbreaking work in the digital asset market since 2017. With a wealth of experience in asset management, Martin leads product development, conducts in-depth research and sets the tone for thought leadership initiatives at MarketVector.