Bitcoin is More Than an Asset Allocation Decision

There was an interesting exchange on a recent episode of Saifedean’s The Bitcoin Standard podcast. In this back-and-forth, Niall Ferguson and Allen Farrington touched on an issue relevant to Financial Advisors and regular investors, that of asset allocation.

Niall Ferguson:

“…the rational actor is engaged in constructing a portfolio that will be diversified, will include scarce things in it, but will also have liquid things in it. And there’s a place for bitcoin in that portfolio.. But you wouldn’t want anybody on this call to think that they should put all their money in bitcoin, I hope, because that would be terrible financial advice. The issue, as I said, is what percentage is the average millionaire going to want to hold, in the form of bitcoin?”

To which Allen Farrington later responded:

“What do you make of the idea that actually nobody should have to asset allocate..? You should be able to just save and then forget about it for years, if not decades, if not centuries.. is that worth being passionate about..?”

Ferguson’s answer:

“I think one should discourage things that are easy and encourage things that are hard. Because  we were given brains, which are quite powerful computers for a reason.”

Resulting in this wry comment by a viewer on Youtube:

Let’s unpack this a bit. 

Bitcoin as an Asset Allocation Decision

On the face of it, Ferguson’s answer makes perfect sense to anyone familiar with Modern Portfolio Theory (MPT) terminology or the mutual fund and ETF portfolios that you will find at a conventional asset manager. Asset allocation is rigorous and process-oriented. After diligently aligning your portfolio to its long-term objectives, these strategies can often be implemented with minimal tinkering. This may reduce the emotional rollercoaster, or time invested in other strategies like trend following, technical analysis, or stock picking.  

There are a few Financial Advisors who have started to point out the benefits to holding bitcoin alongside garden variety assets. While espousing bitcoin’s uncorrelation potential seems less relevant in 2023, narratives about its protection against monetary debasement or portfolio insurance on the global credit market are still alive and well. For regular investors, the most compelling framing may be in simply looking at past risk adjusted returns of balanced portfolios that held a small position.

Whatever our hopes may be for bitcoin (of which this author shares), it is not the common money in the broad economy. By default, most people have at least one foot in the traditional financial system. For this reason, the asset allocation approach is perfectly reasonable. 

But it’s also much more than that, which I will get into next.  

Some Problems 

“Let’s pretend that a portfolio manager digs in, reads the Bitcoin standard.. Understands the deflationary versus inflationary pressures that are about to collide.. and they see it as a separate asset class and something that is insurance and is more like a bond than they’ve admitted, that it should be something they own in their portfolio. Even just 1% in their portfolio.. Well, the first thing they’ve got to do is get their Chief Investment Officer to buy into it. So they’ve got to “orange pill” that guy. Then.. if they’re successful there, they’ve got to get the investment committee to agree to it in order to adjust their mandate…”

– James Lavish on Bitcoin Fundamentals, The Investor’s Podcast Network 

At Simple Wealth Planning, I have tried my hand at incorporating bitcoin into an asset allocation framework and have found it to be partially unsatisfying. For one thing, the products and services are unavailable to do it to the level of expectations of my clients. Moreover, it seems that MPT is opposed to the simple act of saving money that bitcoin offers. 

Imagine trying to act on Niall Ferguson’s advice (as I have), allocating a reasonable percentage of your retirement investments to bitcoin, holding it alongside traditional stocks and bonds, and rebalancing as the portfolio experiences market fluctuation. As a practitioner, there are several issues that this brings up, such as inferior products and added risk. 

For starters, I suspect most people following this strategy are not holding real bitcoin, but a financial product that provides price exposure. Right away this adds additional layers of counterparty risk, fees, and complexity for an investor. While it’s possible to envision real bitcoin being held in custody by retail brokerage firms, that is not the case for most investors in 2023. 

Secondly, this strategy is a non-starter for those who follow the best practice of taking self custody of their private keys. Rebalancing a position that has experienced significant growth, (i.e. taking profits), may be appropriate in some situations. Regularly transacting does not jive well with cold storage security, which is intended by design to be a vault. Taking coins off the exchange, holding for the long-term, and choosing not to rebalance, is the coffee can portfolio for the digital age. 

Moreover, asset allocation, despite claims from the quant community, is more art than science. A firm’s asset allocation policy can also be the byproduct of corporate ego and bureaucratic procedure. In my experience working at a large firm, a portfolio can get sliced up into up to over 20-30 asset classes when an investment committee is involved. Beyond the plain vanilla large caps, small caps, corporates, treasuries, international, emerging markets, etc, you might see an analyst advocate for a mere 1.5% position in a Sweden ETF (to make a higher conviction bet on his bullishness for Swedes). More likely, instead of putting his job on the line for a meaningless position, the analyst may also choose to keep his mouth shut. 

Others would opine that the viability of these asset classes are “proven” through academic research on decades of market data. It’s true that bitcoin cannot be proven by backtesting in this manner. But I must point out that mutual funds, index funds, and ETFs, are new products in the grand scheme of things. There is no first principle, a priori, reasoning that demands we must save and invest in this way. Arguing that ETFs, for example, are the apex of savings technology, might be wealth management’s version of Francis Fukuyama’s fallacy in “The End of History.” 

The investment-by-committee allocators, the academic investors, and even unpretentious bogleheads all have one thing in common. They accept the premise that MPT is the proper framework for where most people should put their money. Yet, it is not impossible that a return to hard money savings could replace these strategies. 

As Farrington alludes to, it is sort of incredible that we demand people learn how to manage an asset allocation portfolio, dividing up their savings into various speculations they barely comprehend, owning hundreds, even thousands of individual securities, all packaged in various financial products. The standard finance bro response to this problem, (guaranteed to go viral on LinkedIn), is usually some version of “THEY SHOULD TEACH PERSONAL FINANCE IN SCHOOLS!!!” 

Still, an appeal to reason and logic is not the most compelling framing for those who get orange-pilled. The plain truth is that.. bitcoin is just more FUN. I have worked with families who save more, consume less, and take more ownership over their finances, all because they were inspired by the bitcoin ethos. Conversely, is anyone changing their life in the name of cold and calculating asset allocation? I was one of those who used to scoff at excessive bitcoin enthusiasm. I no longer scoff. Some of the merits I now recognize are in delayed gratification, a greater understanding in what people own, support of the mission of sound money, and a rejection of investing nihilism. 

Bitcoin on the Balance Sheet

A better framework for incorporating bitcoin into a household’s finances is on the level of the balance sheet and income statement. Ideally, both are optimized in a way that allows a family to live well today, to keep hoarding more bitcoins, and to not sell. This sort of exercise is a pillar of any financial planning process and could be handled by most people on their own or with the counsel of an advisor in this network.

Managing the balance sheet well allows a bitcoin holder to consider their stack, not just in light of their stocks, but their entire financial situation. This can create clarity around decisions regarding debt, real estate, private business ownership, fiat bank savings, and retirement accounts. A speculator making a land grab for a share of the world’s digital property can do so with the knowledge that they are acting with a plan. Perhaps most importantly, self custody of private keys can be prioritized, along with the estate planning consequences that come with it. 

Take a family that is facing a large tax bill because of realized capital gains. They have no credit card debt, a paid-off DeLorean, an emergency fund in place, and several years until retirement. It is entirely possible for a family like this to pay the taxes without needing to liquidate bitcoin holdings, relevant when the price is experiencing a large drawdown. 

While anything over a 1-5% allocation to bitcoin on a balance sheet would make most Financial Planners blush, throughout history it was normal, even encouraged, that people invest less and keep more in cash reserves. A classic proverb is found in the Talmud, “Let every man divide his money into three parts, and invest a third in land, a third in business, and a third let him keep in reserve.” Therefore, the hope that bitcoin savings could replace MPT style investing is not some sort of progressive ideology, but an appeal to the wisdom of the past. If you accept the premise that bitcoin is money, this size of allocation is on the 3 by 5 card of allowable opinion. 

Likewise, a solid income statement would mean a family has cushion in their budget to save 10%-20% (or more) of income, are matching liabilities to the appropriate time frame, and earn a healthy salary. In an economic recession, when both the job market and the bitcoin price may suffer, they are set up to be financially resilient. 

Going through this process of optimizing the balance sheet and income statement clarifies how much exposure one has to the traditional financial system and to an entirely new financial system, the bitcoin network. Now we can take action. 

“Just tell me how much I should buy, already” 

As a Financial Advisor who uses bitcoin, the most common question I receive is “what position size do you recommend?” Considering bitcoin as a mere position in an asset allocation portfolio, while it has its place, is incomplete. In reality, it is much more than a stock, a mutual fund, or an ETF. Bitcoin has potential to replace the 60/40 portfolio and make saving money relevant again in personal financial planning.