TL;DR- Cryptocurrency is highly speculative. Allocate no more than 5% to 10% of your traditional portfolio into digital assets. Stick to Bitcoin and Ethereum as your primary holdings within your crypto portfolio, with little room for smaller altcoin projects. Then buckle up- it’s gonna be a wild ride.
I’m not a financial advisor- and none of this is financial advice!
For now, I’d forget stablecoins like USDT (Tether) and USDC- they’re pegged to the dollar and won’t make your crypto portfolio anything. They’re facing a lot of regulatory scrutiny from the United States Securities and Exchange Commission (SEC), whose rulings other countries tend to follow.
Why cryptocurrency could be a good way to round out your portfolio (those last few percent)
Diversification, they say, is the only free lunch. Diversification will act as your body armor when some of your investments go bad. My business school professors were always touting that the right amount of diversification makes a portfolio safer and has higher returns. That theory is illustrated below with the ‘efficient frontier.’
Cryptocurrency is a totally different beast from stocks, bonds, and physical assets. Its thesis is this: many facets of our society have failed to keep pace with the digital transformation of the last 30 years. While blockchain (crypto’s underlying technology) can solve a lot of these issues, its most popular use case is to compete with fiat money. Clunky and costly cross-border transactions, antiquated stores of value like gold, and everyday mobile payment systems all have targets on their backs.
How much of your portfolio should you have in crypto?
Using traditional financial metrics, there is no way to correctly assign a value to Bitcoin because it doesn’t generate any free cash flow. It’s pure speculation about the technology’s ability to act as a store of value.
That’s ok- the same is true of gold. Gold “doesn’t do anything except sit there and look at you,” in the words of Warren Buffett. Yet we’ve still seen the price of gold quadruple over the last 20 years.
Financial Samurai, the most prominent independent blogger in the world, suggests no more than 10% toward ‘alternative investments’ like Bitcoin. Other investments in this class could include artwork or equity in a friend’s business.
I generally agree with him that no more than 10% of your total asset/investment portfolio goes to digital assets/cryptocurrency investments.
This way, your portfolio can experience fantastic gains if cryptocurrency goes wild, but if cryptocurrency loses 80%, the max you’ll lose is 8% of your total investment portfolio.
[The same sentence as above, but in crypto speak] This way, you’re not getting FOMO and making dumb moves to YOLO cash into Coinbase when the crypto market is going crazy.
What’s the best cryptocurrency portfolio allocation?
The TL;DR here is that 70%+ of your crypto portfolio should be Bitcoin and Ethereum, with a 20%-30% allocation toward other cryptocurrencies or altcoin projects you like. Several financial advisors have agreed with this approach.
I don’t recommend using leverage in cryptocurrency trading. Using leverage in crypto is the definition of insanity. Why am I against leverage and altcoin projects dominating your crypto portfolio? Because the asset class is already 12-15 times more volatile than stocks- and even stocks are considered too volatile for many. Instead of explaining away, let me illustrate some with examples below.
Cryptocurrency Portfolio Allocation case studies
To better examine how different portfolio allocation strategies might play out, let’s do case studies with fictional characters with different portfolio allocation models with cryptocurrency. We’ll evaluate three different characters and their outcomes from different periods:
- High blood pressure Heather
- Boomer Bob
- Anxiety Akshay
We’ll talk about overall portfolio allocation and crypto portfolio allocation. Crypto portfolio allocation should include (in the opinion of most financial experts) Bitcoin, Ethereum, and a small allotment for altcoins.
Allocating too much: High Blood Pressure Heather
Heather is a 28-year-old software engineer in Pittsburgh, making $80,000 annually. She has $30,000 in after-tax savings and around $50,000 in her 401(k) tax-advantaged retirement savings plan.
Instead of investing the recommended amounts of 3% to 10% of her portfolio into cryptocurrency, she decides to bet the house and throw all of her $30,000 after-tax savings into Solana because she believes it’s a fantastic project and will replace Visa as a global payments solution. Her crypto asset allocation is only one cryptocurrency.
She reads headlines about people who were overnight Bitcoin millionaires constantly. She thinks it can happen to her- all she has to do is go big or go home, baby!
Unfortunately, she invested in Solana near its all-time high of $250. Months later, Solana tumbles to $36, and she’s lost 86% of her initial investment.
For her to break even, she needs Solana to 7x from here. That may happen someday, but it sucks too much right now. She is nervous and sometimes has trouble sleeping at night because she has so little savings. She’d probably have to move back in with her parents if she lost her job.
Don’t put too much into cryptocurrency. There’s no way for financial analysts to value crypto because it produces no free cash flow. This makes the price extra privy to investor sentiment, leading to HUGE price swings.
Allocating the right amount: Boomer Bob
Bob is 66 and works in plywood sales in Oregon. He’s semi-retired, working part-time. He has over $1.1 million in investable assets. Bob is a technology enthusiast and believes that fiat currency is terrible. He thinks crypto has a future.
Bob’s investable assets are 70% bonds and traditional investments (safe and low yield), 25% S&P 500 index fund (stocks), and 5% of a diversified crypto portfolio. 5% of his $1.1 million investment portfolio equals $55,000.
Bob plays it smart and allocates 5% of his investable assets into a cryptocurrency portfolio with 60% Bitcoin, 35% Ethereum, and 5% Cardano. He’s got a reasonable crypto portfolio asset allocation. He likes Cardano because it’s one of the most scalable cryptocurrencies.
Bob entered cryptocurrency in the middle of crypto winter- summer 2018. Now it’s four years later. Between summer 2018 and summer 2022:
- Bitcoin has increased from $7,400 to $21,633 (+192%)
- Ethereum has increased from $450 to $1,702 (+278%)
- Cardano has increased from $0.18 to $0.47 (with an all-time high of $3 in 2021!) (+161%)
In the same period, the S&P 500 returned 51%, and Bob’s bonds returned 12.6%. During this time, Bob went against the grain and did not rebalance his portfolio.
Now, when Bob’s at dinner parties and people ask him about crypto investing, he can share his story and the relatively safe gains he’s made with his portfolio. He doesn’t feel like he’s missing out on the vast run-ups in price with Bitcoin.
Allocating too little: Anxiety Akshay
Akshay is a 34 year old FedEx driver in LA. He makes a solid $30/hr with benefits racing his delivery truck all over the San Fernando Valley to get people next-day air Prime packages. He has a 401(k) with traditional investments that his company matches up to 6%, that he’s been able to build up to $25,000. He also holds $15,000 in after tax savings, which he splits between a brokerage account and a savings account for emergencies.
One day in 2014, his buddy told him that Bitcoin was the hottest thing he needed to invest in.
Akshay thinks it’s a scam but decides to open an account on Coinbase and buys $50 worth of Bitcoin, which was then at $700. He miraculously forgets about his account with Coinbase and remembers his account one day in 2022. His Bitcoin is now worth $1,642, a 32x on his original investment.
If only he had invested a little more! A mere 5% of his total investment portfolio would have been $2,000, which would have bought him 2.86 BTC, today worth $65,714. Unfortunately, you can never turn back time.
Are stocks correlated with cryptocurrency?
While not necessarily in the past (<50% correlation), they are now(>50% correlation). The reasons for this include Bitcoin used to be a ‘safe haven’ from the turmoil of the stock market or at least something that wasn’t correlated.
But in recent years, institutional investors like Grayscale (who has an Ethereum trust tradeable on Schwab/E*Trade) have come in and taken considerable positions in digital assets. More and more mainstream investors are incorporating crypto into their asset allocation model.
Do institutional investors tend to invest closer to trends in the stock market?
Factors that affect stock prices and cryptocurrencies
Supply and Demand
Both crypto assets and stocks are subject to the same supply and demand dynamics. Do more people want to buy Bitcoin than want to sell Bitcoin? The price of BTC goes up. More people want to sell Bed Bath & Beyond (BBBY) Stock than want to buy it? The price of BBBY goes down.
Bitcoin maximalists love to claim that there will only ever be 21 million Bitcoin created, but the Earth has a population of 8 billion. It’s a lazy attempt at implying a demand for Bitcoin will significantly exceed supply, thus driving the price of Bitcoin to the moon. Are they right, though?
Geopolitics & Regulatory Changes
Crypto assets experience many more stumbling blocks from a regulatory perspective, adding to their price volatility. Stocks have been around (in some form) since the 17th century and are a known quantity.
Cryptocurrency is incredibly young. Here are recent examples of regulatory stumbling blocks for cryptocurrency: (hyperlinks for ALL)
- China bans all crypto exchanges in 2017
- India’s parliament issues a cryptocurrency ban in 2018, which their supreme court strikes down in 2020
- The US Securities and Exchange Commission (SEC) investigates stablecoins (USDT, USDC)
- The EU considers banning stablecoins
These regulatory changes have steep implications for cryptocurrency prices. Would you want big chunks of your retirement portfolio blowing up because some gray-haired politicians who understand little about economics decide to ban crypto? (no offense to the gray hair club, I’m an emerging member).
Stocks and their corporations are also privy to geopolitics and regulatory changes. The price of oil (and therefore energy stocks) nearly always soars during periods of conflict. Whether it’s an embargo on Iran, a conflict in Ukraine, or an unstable head of state in the Persian Gulf region, energy stocks usually take a wild ride.
Or there’s the example of Enron corporation’s stock losing $74 billion over four years when the US government announced an investigation into possible malpractice.
Investor sentiment & monetary policy
Health of the asset
In stock trading, analysts look at the financial health of a company. Publicly traded companies must post their financials, following a standard set of (still imperfect) accounting practices.
Cryptocurrency? Unfortunately, there’s no such transparency into how crypto projects are going. They don’t create cash flow, but cryptocurrency projects raise funding.
Below is another strategy some use to invest in cryptocurrency.
Take the steady money and throw it on black
Another approach is to take the income you get from a safe/stable asset and use those proceeds to invest in a cryptocurrency portfolio, provided you’re not trying to live off the proceeds of that steady investment income.
With your risk-free investment income, invest in the most speculative investments that have the potential to give you the highest returns. Even if you lose your entire investment, you will never go to the poor house because you will never lose principal.
Assess your risk appetite
For cryptocurrency, the rate of return over a three to five-year period will be anywhere between -80% to +1,000%. Your risk tolerance will be doing some push-ups when you’re holding a crypto portfolio!
Just know that your crypto portfolio will blow up often. Armageddon happens to be a regular occurrence in the crypto market. Don’t be a drama queen- be stoic and HODL (hold on for dear life!) Only allocate a small percentage of your total investment portfolio to cryptocurrency.
My risk appetite
I used to think I was fucking bulletproof risk-wise- that is, I had a super-high risk tolerance. In early 2021 I had so much confidence that I YOLO’d as much as 30% of my overall investment portfolio into altcoin projects like Cardano. Every morning I woke up was like Christmas- the crypto market cap soared.
The gains I was making day over day were more than what I was making at my day job day over day.
I even got onto KuCoin and did some leveraged trading. Using leverage with an asset class as volatile as cryptocurrency is the definition of insanity.
It was awesome for a while until it wasn’t. The shitty days started coming and didn’t stop. Bitcoin is down 60% since then, and altcoins like Cardano and Polkadot are down 70%-80%. It turns out I’m not cool losing that much money. I was able to tax loss harvest my crypto losses for a slight boost at the beginning of 2022, but for the most part, I cemented my losses by liquidating my portfolio
Don’t waste time
Are you pulling out your phone every two and a half minutes to check crypto balances? Be aware of the psychological ride and waste of time that crypto does to people. You’ll never get your time back, and some argue that focus is the most essential skill of the 21st century. If trading crypto will have you constantly distracted, don’t do it- or set it and forget it.
What you should do if Bitcoin moons and you make bank
I say turn that monopoly money into something tangible (or more real), like paying down some home equity or throwing it into a low-cost S&P 500 index fund.
Keep in mind- you only need to get rich once!
Tracking your cryptocurrency portfolio
I’m not affiliated with them, but I like CoinStats a lot for tracking my crypto investments. Chances are you’ve got crypto investments lying around in several places- software wallets like MetaMask, hardware wallets like Ledger, and exchanges like Coinbase and KuCoin. Coinstats makes tracking your balances way easier.
Talk to some financial professionals
I’m not a financial expert or financial advisor! I’m a product manager in tech who has an MBA from Dartmouth and a few engineering degrees. None of this is financial advice.
Cryptocurrency can be a nice little seasoning/boost to your traditional portfolio. Crypto is a volatile asset class, but it is a good diversification tool against traditional assets like stocks and bonds. Financial planners advise against adding more than 10% of your diversified portfolio into risky assets like cryptocurrencies.
Think long and hard before making any financial decision, and stay on the righteous path! Stay safe out there.