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Katherine Dowling has an analogy that may be useful for investors thinking of buying cryptocurrency like bitcoin and wondering what amount is appropriate.
It’s “like cayenne pepper,” said Dowling, general counsel and chief compliance officer at Bitwise Asset Management, a crypto money manager. “A little goes a long way” in a portfolio, she explained earlier this month at Financial Advisor Magazine’s annual Invest in Women conference in West Palm Beach, Florida.
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Ivory Johnson, a certified financial planner and member of CNBC’s Financial Advisor Council, said the description is apt.
“The more volatile an asset class is, the less of it that you need,” said Johnson, who founded Delancey Wealth Management, based in Washington, D.C.
A 2% or 3% allocation is ‘more than enough’
Cryptocurrencies are digital assets, a category that should be considered an “alternative investment,” Johnson said.
Other types of alts may include private equity, hedge funds and venture capital, for example. Financial advisors generally consider them separate from traditional portfolio holdings like stocks, bonds and cash.
Allocating 2% or 3% of one’s investment portfolio to crypto is “more than enough,” Johnson said.
Let’s say an asset grows by 50% this year, and an investor holds a 1% position. That’s like having a 5% position in another asset that grew 10%, Johnson said.
Whether investors buy in to crypto — and how much they hold — will depend on their tolerance and capacity for risk, Johnson said.
For example, long-term investors in their mid-20s can afford to take more risk because they have ample time to make up for losses. Such a person may be able to stomach substantial financial losses and may reasonably hold 5% to 7% of their portfolio in crypto, Johnson added.
However, that allocation would most likely not be appropriate for a 70-year-old investor who can’t afford to subject their nest egg to major losses, he said.
“Bitcoin and other cryptocurrencies are a very speculative investment and involves a high degree of risk,” investment strategists at Wells Fargo Advisors wrote in a note last year. “Investors must have the financial ability, sophistication/experience and willingness to bear the risks of an investment, and a potential total loss of their investment.”
Crypto is ‘an incredibly volatile asset’
Crypto prices have been on a wild ride lately.
Bitcoin, for example, surged to an all-time high earlier in March. It topped $73,000 at its peak, though it has since retreated to less than $69,000.
Bitcoin prices had collapsed heading into 2022, and shed about 64% that year to below $20,000. By comparison, the S&P 500 stock index lost 19.4%.
Prices have since quadrupled from their low point in November 2022, as of late Wednesday. They’ve soared more than 50% year to date, while the S&P 500 is up about 9%.
Bitcoin is about eight times as volatile as the S&P 500, Johnson wrote in a Journal of Financial Planning article in December 2022, citing data from the Digital Asset Council for Financial Professionals.
The Crypto Volatility Index was about six times higher than the CBOE Volatility Index as of Wednesday.
“It’s still an incredibly volatile asset,” Bitwise’s Dowling said. “It’s not for everybody.”
Investing in crypto became easier for many investors after the Securities and Exchange Commission approved a slew of spot bitcoin exchange-traded funds in January, in a first for the asset class.
Investors may wish to consider dollar-cost averaging into crypto, Johnson said. This entails buying a little bit at a time, until reaching one’s target allocation. Investors should also rebalance periodically to ensure big crypto profits or losses don’t tweak one’s target allocation over time, he said.