What You Need to Know
- A Morningstar study found that adding Bitcoin to a 60/40 portfolio adds risk and can add more volatility.
- Clients will need nerves of steel to hold onto Bitcoin in times of increased volatility.
- Advisors need to counsel clients on the downside of Bitcoin investments.
Cryptocurrencies have bred skepticism among advisors, but some are starting to come around. A Grayscale paper found that 10% of advisors were recommending crypto for portfolios, and a Financial Planning Association survey found even more optimism about the emerging asset class.
The 2021 FPA survey, released in June, found that 26% of advisors plan to increase their use or recommendations of cryptocurrencies in client portfolios over the next 12 months, up from less than 1% a year ago.
But those advisors would be wise to proceed with caution since, as Morningstar put it in the title of a recent article, even a Little Bitcoin Can Change Your 60/40 Portfolio a Lot, and not always in a good way.
Here are four findings from that article by Adam Millson, manager research analyst for Morningstar, in which he reviewed Bitcoin’s historical volatility and returns versus stock and bond portfolios.
Caveats of the study include that it is a “backward-looking exercise of a wildly volatile asset without a very long history,” Millson states. The research also ignored related costs of the cryptocurrency, “which can be significant,” he added.
1. Volatility Matters
Although the likes of Ark Invest CEO Cathie Wood can stomach the ups and downs of Bitcoin — which had as much as a 1,300% return in 2017 and 300% gain in 2020 — the drops are significant. The paper compares a rolling one-year standard deviation using returns over the life of the CMBI Bitcoin Index (launched in July 2010) to a 60/40 portfolio tracking the Morningstar Global Markets Index and Morningstar US Core Bond Index — rebalanced monthly.
Millson found that Bitcoin was not only 13 times more volatile over that period than a 60/40 portfolio, but also 8.6 times more volatile than a 60/40 portfolio over a one-year trailing period.
2. The Risk Factor
Millson points out that different asset classes in a portfolio contribute different amounts of risk. In a typical 60/40 portfolio, equities contribute about 90% of risk. “With that in mind, the impact on the risk profile of the same portfolio by introducing bitcoin, which is incredibly more volatile, is jarring,” he writes.