Asset allocation and weighting is a question looming on every investor’s mind and a conversation that I have with clients daily. Most financial planners are generally tasked with approaching this question from a stock, bond, and cash perspective, and for retirees, with possible additional consideration of some “guaranteed” retirement income streams such as Social Security, pensions, and/or annuities. But what happens when bitcoin enters the conversation? That is a loaded conversation that I will do my best to unpack without putting you to sleep.
Laying the foundation
If you read posts from laser-eyed bitcoiners on Twitter you will conclude that the only logical allocation is 100% bitcoin. Sit down with a slacks-and-blazer-wearing financial advisor and you will be barked at that owning any bitcoin beyond 0% is simply you giving into a beanie baby-like craze (maybe they will tell you to buy 1% of your portfolio simply so you will stop asking them about it). Ask your neighbor and they will regurgitate what they heard in the news, what they read on twitter, or what their slacks-and-blazer-wearing financial advisor told them. So, what is the correct answer? Is there a correct answer? And if there is one, how do I find out? Is it set in stone or does the amount shift based on personal circumstances? Let’s find out. My goal in this article is to provide you with a framework to assess portfolio construction. I am not going to tell you what percentage allocation you should arrive at (so get off my back, compliance people). Let’s get everything on the table, so as you ask this question, you can do so considering the massive number of factors that weigh in on this decision.
Note with the number of factors that we will visit in this piece, the following should be viewed as themes and not comprehensive discussions for any variable. Each of the following variables can be more exhaustively written upon…but you signed up to read a blog, not a book.
Risk tolerance and risk capacity
When most people speak to their “risk profile” with investing, they generally approach this from risk tolerance while neglecting the need to address risk capacity. What is the difference? Risk tolerance is the investor’s willingness to take on market volatility and stay invested. Risk capacity is the investor’s financial ability to absorb adverse portfolio conditions and not have those poor events negate their ability to achieve their goal(s).
Example of risk tolerance: You are at a theme park with a group of friends. You are not sure if you enjoy rollercoasters but all your friends are about to hop on board “The Widow Maker,” the newest, fastest ride in the park. You decide to go for it. You buckle in and begin the ascent to the top then plummet down at a thrilling pace. You are not sure if you are into this. Then you hit a massive loop. At that moment you decide that roller coasters are not for you so you take off your seatbelt mid-loop. You made the critical error of misgauging your risk tolerance before getting on the ride then the second critical error of making a major decision with logic thrown to the wind.
Example of risk capacity: You have $100 today. You need $100 tomorrow for a birthday gift for your spouse. You have saved for this gift for months. If you show up to the store tomorrow with only $99, you can’t get the gift. In this case, it would be foolish to take that $100 and invest it, hoping to turn that $100 into $101 by tomorrow. That possible extra $1 would not provide the upside satisfaction that the despair that would come if you lost $1 and were unable to buy your spouse their birthday gift. You don’t have the ability to absorb this risk.
Risk capacity example 2: You have $100 today. You need, in 30 years, that $100 to be $100 in today’s purchasing power. Historically speaking, you cannot risk simply keeping the $100 not invested over the 3 decades. That $100 will still be there, but the actual intended goal of retained purchasing power will have eroded, due to inflation, to only 41% of today’s purchasing power (assuming annual inflation of 3%). You cannot afford this risk. You do not have the capacity for it.
Sequence of return risk
Before we dive into sequence of return risk, it is important to note that risk and volatility are not synonymous. Most people, when looking at an asset that has high gyrations, associate that asset as being risky. Meanwhile, when they look at an asset that displays zero or very little movement, associate that asset with being safer. Risk and volatility do become more correlated as time horizons become compressed, but to shortcut that to making them equivalents is false and can be lethal to an investment portfolio. For a direct example of this, re-read the above paragraph about the $100 that is kept in cash over the 30-year timeframe. That $100 experienced zero nominal volatility, yet this move was risky considering inflation-adjusted returns. If I draw a nice bath, fill it with lavender and bubbles, pour myself a nice beverage, then lower myself into the bathtub until I am fully submerged, that is not a volatile experience. It felt (and smelt) great. However, I am going to drown. It is a smooth, (temporarily) relaxing trip to death. Volatile? No. But guaranteed risky.
As stated above, risk and volatility are not synonymous. However, as time horizon gets compressed, they do become more correlated. This is due to the impact of sequence of returns. This is simply illustrated in the above example of having $100 today and needing exactly $100 tomorrow. From a more general perspective, when cashflow occurs (contributions into or distributions from), average returns of an investment portfolio matters less than the order that the returns take place. The sooner one needs to access capital, the less volatile of an asset they should place said capital into.
Bitcoin’s nominal vs. real growth
If money is continually printed, bitcoin can, in theory, continue to go up in “price” but not appreciate in purchasing power. This is nominal growth. However, for bitcoin to take on real growth, this will come at the expense of other assets. This phenomenon, in my opinion, will take place by de-monetizing other assets that currently have a monetary premium and simply shifting that bloated value into bitcoin. This impact could be blatant, or it could be masked through the continued nominal growth of the adversely-impacted assets. This implies that owning a small amount of bitcoin would serve as an insurance policy in the event of the de-monetization of bloated assets in favor of bitcoin.
Current and future savings rates
When considering how much bitcoin you’d like to own, it may be important to consider not only the percentage of portfolio that would constitute today, but also extrapolate expected future savings and pull those, to a degree, into the present.
Example: 25-year-old Ted has $30,000 currently set aside for retirement investing. His current savings rate is 25%, allowing him to save $15,000 of his $60,000 salary annually. Further, due to his line of work, he expects by the age of 35 to have an annual income of $300,000 and, even with adding in a wife and kids and succumbing to lifestyle creep, have an annual savings amount of $80,000. Ted could take all $30,000, 100% of his current retirement savings, and purchase bitcoin. At that moment Ted would be 100% allocated. However, if we account for Ted’s healthy savings rate, this will be recouped in 2 years of saving. Further, in a decade Ted will be able to save this amount every 3 months. So, in Ted’s situation, a 100% present portfolio is less extreme than what first meet the eye.
Now I know the critiques will come at me so let us address this point. If bitcoin goes to zero and Ted had bought a diversified stock portfolio with that initial $30,000 instead of buying bitcoin, that would make a big difference over time. For instance, if that $30,000 had grown by 10% per year until Ted was 60, that would be just over $800,000. This is a risk Ted was comfortable with taking.
Other assets
I’m not speaking to stocks or bonds, as those types of other assets are already factored into the asset allocation and weighting conversation. But what about other assets? Real estate holdings? Businesses? High net present value pensions? These can impact allocation, as well.
Example: 43-year-old Bob owns 20 bitcoin, bringing 50% of his liquid retirement bucket in bitcoin. However, Bob also owns a great business in town. He’s ensured that his business is not just a job that he created for himself, but is also a sellable asset. He has a solid growth and exit plan, keeps a healthy pulse on the value of his business, regularly works to ensure that it will fetch a multiple at the higher end of the spectrum when he decides to sell, and when desired, could reasonably sell to a host of buyers, be it an internal succession, a local competitor, or a private equity backed company. Bob’s business is currently valued at $7,000,000. Bob, being a simple guy, would be happy to live off $150,000 per year when he decides to sell his business.
Bob’s situation allows for what is initially perceived as a high allocation weighting due to how he has constructed his business as an asset. One must consider the entire financial scenario.
Known inheritance
This situation requires a high level of confidence in an expected inheritance, must consider the unknowns of when said inheritance will come, and consider the asset(s) presently making up the future inheritance. As with the above example, while this is not typical, it is important to factor in for those to whom it does apply. Discussing inheritance planning with family can be awkward. I have heard dozens of families say that they do not want their children to view their inheritance as something they are just waiting around for, and thus, neglect to ever have any sort of healthy conversation around it. Contrarily, avoiding the conversation about inheritance has caused countless fallouts with families once the giving generation has left the scene and left the next generation to figure things out without informed family conversations. With that said, if healthy conversations around inheritance planning can be had, it can be helpful with the financial planning for the next generation, not to mention help protect the relationships of the beneficiaries.
Example: Steve and Karen are both 67 years old and enjoying retirement. They have $1,500,000 across IRAs, Roth IRAs, and Brokerage accounts. Of their $1,500,000, 20% is allocated to bitcoin. While Steve and Karen have more free time than they did while working, they do stay busy helping take care of Steve’s dad who is 90 years old and battling cancer. Steve has had conversations with his dad over the years and knows that his dad has a $1,000,000 life insurance policy on himself with Steve as the sole beneficiary.
While Steve and Karen being allocated at 20% bitcoin in their existing portfolio may seem excessive, one needs to consider the additional $1,000,000 windfall that they will receive within the next few years. Look at it this way; that $1,000,000 is currently a cash position. If Steve and Karen were, instead, sitting in a portfolio at a 60% stocks/40% bonds allocation, they would have $900,000 stocks and $600,000 bonds. Then drop in that additional $1,000,000 of cash and their portfolio suddenly becomes weighted to 36% stocks/64% bonds and cash. Further, consider that many bitcoiners view bitcoin as a hedge against fiat currencies, the very fiat that 40% of their (eventual) portfolio is sitting in. Again, the context of an entire financial scenario is necessary to assess all the risks of a portfolio and craft a truly proper allocation.
Conclusion
You are probably upset that this was yet another article that misled you to think you would be provided with a hard amount of bitcoin you should own. I do not know all the factors that would inform that decision and, as you can see, there are a lot of those factors. I hope that this provides a starting point for you to begin making an informed decision for your asset allocation. If you would like to talk it over with a financial planner, the planners at the Bitcoin Financial Advisors Network would love help.
Noteworthy related resources:
“How Do You Take On More Risk In A Portfolio?” – Michael Kitces, 2011
“Retirement Date Risk – The Impact Of Sequence Of Returns Risk On Those Still Accumulating For Retirement” – Michael Kitces, 2016
“Understanding Sequence Of Return Risk – Safe Withdrawal Rates, Bear Market Crashes, And Bad Decades” – Michael Kitces, 2014
Nakamoto Portfolio – https://nakamotoportfolio.com/
Prior to starting Intentional Living FP, I worked primarily with the standard clients of most wealth management firms— financially successful families seeking guidance with the wealth they’ve accumulated over decades. While I cherish each client I’ve served, I came to find the clients I enjoy most: families that desire to achieve early financial independence for the sake of spending significant time with the people they care about, doing the things they enjoy.
I am a CERTIFIED FINANCIAL PLANNER™, and the message I tell every client I work with is that my role is to guide— to live where my clients’ lives and money intersect so they can live the life they want to live. The money is simply a tool, a resource that is there to help you live the life you want.
When I’m not engaged in a conversation with people about life, priorities, and doing what is important to them, I can be found chasing around my kids, Atticus, Asher, Arlo, & Adeleine, spending time with my wife, Kendra, or out on an adventure.