Until this year, the conventional wisdom was that Bitcoin (BTC 0.38%) should account for no more than 1% of your portfolio. Maybe as high as 3% if you are very aggressive or have a very long time to go until retirement.
But one top financial advisor, Ric Edelman, is now telling people that it's time to boost that Bitcoin allocation to at least 10% and perhaps even as high as 40%. Edelman is in the Barron's Financial Advisors Hall of Fame, so he obviously knows a thing or two about investing. So what's causing him to ratchet up his suggested Bitcoin allocation?
Bitcoin and the 60/40 portfolio
One fundamental point Edelman makes is that the standard 60/40 portfolio (60% stocks and 40% bonds) may no longer be appropriate for most people. People are simply living too long these days, and allocating 40% of your portfolio to bonds won't get you there.
As Edelman points out, average life expectancy in America could rise as high as 100 during the next few decades thanks to technological and medical advances. The modern 60/40 portfolio dates back to the 1950s when life expectancies were much lower. As a result, investors had much shorter time horizons, and a 60/40 portfolio made sense.
"If you're a financial advisor and you had a 30-year-old client who was saving for their long-term future, you would tell them to put 100% of their money in stocks, because they have 50 years to go," Edelman recently told CNBC. "Today's 60-year-old is kind of like yesterday's 30-year-old."
Image source: Getty Images.
And that's where Bitcoin comes into the picture. During the past decade, Bitcoin has consistently been one of the top-performing asset. In fact, in most years, Bitcoin has been the top-performing asset. No other asset even comes close, not even high-flying tech stocks. Those extraordinary returns are important because you need to build your portfolio to keep up with rising life expectancies.
Is a 10% allocation too high?
In theory, all of this makes sense. Adding even a tiny allocation of Bitcoin to your portfolio can help to turbo-charge its returns, thereby ensuring that you'll have enough money for retirement. But is 10% too high? After all, that's 10 times higher than the 1% that's currently recommended.
CRYPTO: BTC
Key Data Points
Last year, BlackRock Inc. (BLK 3.57%) -- the company behind the popular iShares Bitcoin Trust (IBIT 3.66%) exchange-traded fund (ETF) -- released a report called "Sizing Bitcoin in Portfolios." It used modern portfolio theory to examine the impact of adding progressively more Bitcoin to a conventional 60/40 portfolio. In other words, it took into account not just the additional returns made possible by Bitcoin but also the additional risk that Bitcoin introduces to the portfolio.
Keep in mind that Bitcoin is a historically volatile and risky asset, prone to enormous market corrections and significant declines. In 2022, for example, Bitcoin fell 65%, and investors with heavy allocations to Bitcoin took a beating. So, if you're a rational investor, you need to take into account the additional risk posed by Bitcoin.
What BlackRock found is that the optimal allocation for Bitcoin is still just 1% to 2%. Once you boost your Bitcoin allocation to the 4% mark, really strange things start to happen to your portfolio. It suddenly starts to perform in ways that you might not expect, given the dramatic ups and downs that Bitcoin has historically seen. At a 4% allocation, Bitcoin does not account for 4% of the risk in your portfolio; it now accounts for 14% of the risk.
So imagine what would happen if you allocated 10%, 20%, or 30% of your portfolio to Bitcoin. At some point, it wouldn't matter what other elements of your portfolio were doing. All that would matter is what Bitcoin is doing.
The rebuttal to this, of course, is that Bitcoin is a remarkably powerful portfolio diversifier. As BlackRock has shown, Bitcoin is completely uncorrelated with any major asset class. It doesn't move in sync with stocks, bonds, gold, or commodities. So adding a risky asset like Bitcoin to your portfolio can actually make your overall portfolio less not more risky.
In search of the optimal Bitcoin allocation
Bitcoin is a risky and volatile asset, and should only be added to a portfolio if you are comfortable with its overall risk-reward profile. We now have over a decade's worth of performance data to suggest that Bitcoin should indeed be added to a portfolio. And we now have the tools -- the new spot Bitcoin ETFs -- to make it possible for investors to achieve precisely the portfolio allocation they desire.
For most investors, a 1% allocation may be optimal. But to me, that seems a bit low. As BlackRock suggests, ramping that up to at least 2% makes sense. But before you go higher than that, make sure you understand exactly what Bitcoin is doing to your portfolio, both in terms of risk and reward.
