Bitcoin Integration in Traditional 60/40 Portfolios: A 4-Year Analysis

Keywords: Portfolio Performance, Asset Allocation, Bitcoin, CAGR, Standard Deviation, Max Drawdown, Sharpe Ratio, Sortino Ratio, Market Correlation

Abstract

This research investigates the performance of two distinct investment portfolios over various 4-year periods, aiming to assess the impact of incorporating Bitcoin into a traditional 60/40 portfolio. The portfolios under scrutiny include a conventional 60% equity (VTI — Vanguard Total Stock Market ETF)/40% fixed-income allocation, and a modified 60/40 portfolio with a 2% allocation to Bitcoin, replacing 2% of VTI. The study covers seven different 4-year periods from 2014 to 2023, allowing for a comprehensive analysis of portfolio behavior across diverse macroeconomic conditions and the nature of crypto cycles. The analysis assumes that investors are willing to hold Bitcoin for no less than 4 years, as this is the time required to capture the different stages of bullish and bearish cycles in the cryptocurrency industry.

Key performance metrics evaluated include Compound Annual Growth Rate (CAGR), Standard Deviation, Maximum Drawdown, Sharpe Ratio, Sortino Ratio, and Stock Market Correlation. Results demonstrate that the 60/40 portfolio with a 2% Bitcoin allocation consistently outperforms the traditional 60/40 across all evaluated periods. Introducing a 2% Bitcoin allocation enhances the overall CAGR of the modified 60/40 portfolio. Furthermore, the Sharpe and Sortino Ratios highlight improved risk-adjusted returns for the modified portfolio. However, the modified portfolio evidences a higher Standard Deviation and Maximum Drawdowns across multiple periods. Moreover, market correlation analysis indicates that Bitcoin does not introduce a significant diversification element, although it manages to reduce slightly the correlation coefficient with the market.

This research provides empirical evidence supporting the proposition that adding a modest 2% allocation of Bitcoin to a traditional 60/40 portfolio can yield consistent benefits for a 4-year horizon. Long-term investors seeking improved risk-adjusted returns may find value in considering such a modified asset allocation strategy, as evidenced by the performance metrics over multiple 4-year periods.

Portfolios

First, we evaluate the effectiveness of a conventional 60/40 and the modified portfolio within the context of its most commonly utilized structure, designed for US investment products, from January 2020 through November 2023. For the equity component, we will consider the Vanguard Total Stock Market Index Fund (VTI), and for the bond portion, our benchmark will be the Vanguard Total Bond Market Index Fund (BND).

As the name implies, the 60/40 portfolio allocates 60% of its assets to the VTI ETF and the remaining 40% to the BND ETF. Given that the value of our investments is subject to market fluctuations, the portfolio’s target allocation will vary accordingly. Consequently, after each month, the portfolio will rebalance to realign with these predetermined weightings, ensuring adherence to the target allocation.

The 58–40–2 modified 60/40 portfolio refers to an adjusted investment strategy where 2% of the traditional 60/40 portfolio, which typically consists of 60% stocks (such as represented by VTI, the Vanguard Total Stock Market ETF) and 40% bonds, is replaced by Bitcoin.

In this context, the modified allocation is as follows: 58% remains invested in stocks, 40% is allocated to bonds and 2% is allocated to Bitcoin.

Throughout 2020, the global economy faced unprecedented challenges primarily due to the COVID-19 pandemic. The pandemic led to widespread lockdowns, disruptions in supply chains, and a sharp decline in economic activity. Governments worldwide implemented stimulus measures to counteract the economic downturn. Financial markets experienced significant volatility, with major indices experiencing sharp declines followed by a notable recovery later in the year as hopes for vaccines and economic reopening emerged.

In 2021, many countries witnessed a strong economic recovery, although some sectors continued to face challenges. Central banks maintained accommodative monetary policies to support the recovery. Global stock markets generally performed well during 2021, reaching new highs in several regions.

In 2022, the focus shifted to managing inflationary pressures and potential policy tightening. Central banks started signaling a shift towards a more hawkish stance, considering interest rate increases and other measures to address inflation concerns. Geopolitical tensions and supply chain disruptions also played a role in shaping market dynamics. Overall, while economic recovery continued, uncertainties related to inflation and geopolitical events influenced market sentiment, resulting in periods of volatility.

2020–2023

During the period from January 2020 to November 2023, the selected portfolios demonstrated varying performances. The 60/40 Portfolio started with an initial balance of $10,000 and ended with $12,399.52, resulting in an inflation-adjusted end balance of $10,356.36. The annualized return (CAGR) was 5.64%, or 0.90% when adjusted for inflation. The portfolio exhibited a standard deviation of 13.78%, with the best year yielding a return of 15.70%, and the worst year experiencing a loss of -16.95%. The maximum drawdown was -20.69%. The Sharpe Ratio was 0.34, and the Sortino Ratio was 0.50. The portfolio showed a correlation of 0.99 with the stock market.

On the other hand, the 58/40/2 Portfolio, also starting with $10,000, concluded with an end balance of $13,192.45, and an inflation-adjusted balance of $11,018.64. Its annualized return (CAGR) was 7.33%, or 2.51% when adjusted for inflation. The standard deviation was 14.45%, with the best and worst years experiencing returns of 21.39% and -17.85%, respectively. For this portfolio, the maximum drawdown was higher (-21.36%), as well as the Sharpe Ratio (0.44) and the Sortino Ratio (0.67). This portfolio demonstrated a correlation of 0.98 with the stock market.

2019–2022

Both portfolios exhibited positive performance during the period from January 2019 to December 2022.

For the 60/40 Portfolio, the initial investment of $10,000 grew to an end balance of $13,433.76, with an inflation-adjusted end balance of $11,371.42. The annualized return (CAGR) was 7.66%, or 3.27% when adjusted for inflation. The portfolio demonstrated a standard deviation of 13.02%, a Sharpe Ratio of 0.55, and a Sortino Ratio of 0.81. The Sortino Ratio being higher suggests that the portfolio’s risk-adjusted returns, specifically concerning downside volatility (negative deviation from the mean), are relatively better.

On the other hand, the 58/40/2 Portfolio, with a 2% allocation to Bitcoin, showed even stronger performance. The initial $10,000 investment grew to an end balance of $14,170.53, and the inflation-adjusted end balance was $11,995.09. The annualized return (CAGR) was 9.11%, or 4.65% when adjusted for inflation. The standard deviation was 13.61%, and the portfolio had a Sharpe Ratio of 0.63 and a significantly higher Sortino Ratio of 0.96. The higher Sortino Ratio suggests that the 58/40/2 Portfolio not only achieved better risk-adjusted returns than the 60/40 Portfolio but also specifically excelled in mitigating downside risk, which is important for risk-averse investors. The 58/40/2 Portfolio outperformed the 60/40 Portfolio in terms of both raw returns and risk-adjusted metrics, with a higher Sortino Ratio indicating a more favorable performance, particularly in managing downside volatility.

2018–2021

During the period from January 2018 to December 2021, both selected portfolios, the 60/40 Portfolio and the 58/40/2 Portfolio, demonstrated robust performance.

For the 60/40 Portfolio, the initial investment of $10,000 grew to an end balance of $15,662.73, with an inflation-adjusted end balance of $13,849.39. The annualized return (CAGR) was 11.87%, or 8.48% when adjusted for inflation. The portfolio exhibited a standard deviation of 10.85%, a Sharpe Ratio of 0.98, and an impressive Sortino Ratio of 1.57. The Sortino Ratio being substantially higher suggests that the portfolio not only generated high risk-adjusted returns but excelled in mitigating downside risk, making it particularly appealing for risk-averse investors.

Similarly, the 58/40/2 Portfolio, with a 2% allocation to Bitcoin, showed even stronger performance. The initial $10,000 investment grew to an end balance of $16,472.38, and the inflation-adjusted end balance was $14,565.31. The annualized return (CAGR) was 13.29%, or 9.86% when adjusted for inflation. The standard deviation was 11.37%, and the portfolio had a Sharpe Ratio of 1.05 and a significantly higher Sortino Ratio of 1.79. Like in the previous period, the higher Sortino Ratio indicates superior risk-adjusted returns, particularly in mitigating downside risk.

The inclusion of Bitcoin in the portfolio again contributed to its overall strong performance, and the higher Sortino Ratio suggests a better ability to manage downside volatility. Investors seeking a balance of risk and return may find the 58/40/2 Portfolio more attractive based on these metrics.

2017–2020

This period includes the years of the 2017 bull market, highlighted by the extreme volatility and speculative nature of the cryptocurrency market, demonstrating how prices could experience rapid and significant swings in a short period.

The period from 2017 to 2018 was marked by a significant and highly volatile cycle in the price of Bitcoin, as well as other cryptocurrencies. In 2017, Bitcoin experienced an unprecedented surge in value, reaching an all-time high of nearly $20,000 in December 2017. This surge was driven by increased mainstream awareness, growing interest from institutional investors, and speculative trading. Bitcoin’s rapid ascent caught the attention of the public and media, sparking a wave of investments in various cryptocurrencies.

The market then experienced a sharp correction in early 2018. The price of Bitcoin and other cryptocurrencies declined substantially, leading to a bear market. Several factors contributed to the downturn, including regulatory concerns, security issues, and a general cooling of the speculative fervor that had driven the earlier surge.

For the 60/40 portfolio, an initial investment of $10,000 grew to an end balance of $15,594.03, with an inflation-adjusted end balance of $14,454.03. The annualized return (CAGR) was 11.75%, or 9.65% when adjusted for inflation. The portfolio exhibited a standard deviation of 10.36%, indicating relatively lower volatility.
The Sharpe Ratio was 0.99, reflecting a favorable risk-adjusted return.
The Sortino Ratio was notably high at 1.57, indicating superior risk-adjusted returns with a focus on downside volatility. The maximum drawdown was -12.29%, showcasing the largest peak-to-trough decline during the period.

Regarding the 58/40/2 Portfolio: The initial $10,000 investment grew significantly to an end balance of $19,876.49, with an inflation-adjusted end balance of $18,423.41. The annualized return (CAGR) was 18.74%, or 16.50% when adjusted for inflation, indicating higher returns compared to the 60/40 Portfolio. The standard deviation was 11.88%, slightly higher than the 60/40 Portfolio but still within a reasonable range. The Sharpe Ratio was 1.39, indicating strong risk-adjusted returns. The Sortino Ratio was notably high at 2.56, indicating exceptional risk-adjusted returns with a focus on downside volatility. The maximum drawdown was -12.61%, similar to the 60/40 Portfolio but with significantly higher returns.

The inclusion of Bitcoin in the portfolio contributed to its overall strong performance, as evidenced by the higher annualized returns and superior risk-adjusted measures, particularly the Sortino Ratio. However, it’s important to note that the higher returns also came with slightly increased volatility, which is a trade-off investors may consider based on their risk tolerance and investment objectives.

2016–2019

During the period from January 2016 to December 2019, both the 60/40 Portfolio and the 58/40/2 Portfolio exhibited positive performance, but with distinct differences:

60/40 Portfolio:

End Balance: The initial investment of $10,000 grew to an end balance of $14,651.05, with an inflation-adjusted end balance of $13,485.17.
Annualized Return (CAGR): The portfolio achieved an annualized return of 10.02%, or 7.76% when adjusted for inflation.
Risk Metrics: The standard deviation, a measure of volatility, was relatively low at 7.22%, indicating a smoother ride compared to the 58/40/2 Portfolio. The maximum drawdown, representing the peak-to-trough decline, was -8.38%.
Risk-Adjusted Metrics: The Sharpe Ratio was 1.18, reflecting a good risk-adjusted return. The Sortino Ratio was notably high at 1.83, indicating superior risk-adjusted returns with a focus on downside volatility.
Correlation: The portfolio demonstrated a high correlation of 0.99 with the stock market, indicating a strong alignment with overall market trends.

58/40/2 Portfolio:

End Balance: The initial $10,000 investment grew significantly to an end balance of $18,163.90, with an inflation-adjusted end balance of $16,718.49.
Annualized Return (CAGR): The portfolio achieved a higher annualized return of 16.09%, or 13.71% when adjusted for inflation, compared to the 60/40 Portfolio.
Risk Metrics: The standard deviation was 8.79%, indicating slightly higher volatility compared to the 60/40 Portfolio. The maximum drawdown was -8.66%, similar to the 60/40 Portfolio.
Risk-Adjusted Metrics: The Sharpe Ratio was 1.60, indicating strong risk-adjusted returns. The Sortino Ratio was notably high at 3.23, indicating exceptional risk-adjusted returns with a focus on downside volatility.
Correlation: The portfolio demonstrated a lower correlation of 0.80 with the stock market, indicating a somewhat lower alignment with overall market trends compared to the 60/40 Portfolio.

The 58/40/2 Portfolio outperformed the 60/40 Portfolio in terms of both raw returns and risk-adjusted metrics. The inclusion of Bitcoin in the portfolio contributed to higher annualized returns and exceptional risk-adjusted returns, particularly evident in the significantly higher Sortino Ratio.
Despite the higher returns, the 58/40/2 Portfolio also exhibited slightly higher volatility, as seen in the higher standard deviation. Investors should consider this trade-off between risk and return based on their risk tolerance and investment objectives. The lower correlation of the 58/40/2 Portfolio with the stock market suggests that the inclusion of Bitcoin introduced some diversification benefits, potentially helping mitigate overall portfolio risk.

2015–2018

60/40 Portfolio:

End Balance: The initial investment of $10,000 grew to an end balance of $12,109.97, with an inflation-adjusted end balance of $11,318.45.
Annualized Return (CAGR): The portfolio achieved an annualized return of 4.90%, or 3.14% when adjusted for inflation.
Risk Metrics: The standard deviation, a measure of volatility, was 6.91%, indicating moderate volatility. The maximum drawdown, representing the peak-to-trough decline, was -8.08%.
Risk-Adjusted Metrics: The Sharpe Ratio was 0.61, reflecting a moderate risk-adjusted return. The Sortino Ratio was 0.89, indicating relatively good risk-adjusted returns with a focus on downside volatility.
Correlation: The portfolio demonstrated a high correlation of 0.98 with the stock market, indicating a strong alignment with overall market trends.

58/40/2 Portfolio:

End Balance: The initial $10,000 investment grew to an end balance of $12,970.20, with an inflation-adjusted end balance of $12,122.45.
Annualized Return (CAGR): The portfolio achieved a higher annualized return of 6.72%, or 4.93% when adjusted for inflation, compared to the 60/40 Portfolio.
Risk Metrics: The standard deviation was 7.25%, slightly higher than the 60/40 Portfolio. The maximum drawdown was -8.80%, similar to the 60/40 Portfolio.
Risk-Adjusted Metrics: The Sharpe Ratio was 0.82, indicating a somewhat better risk-adjusted return compared to the 60/40 Portfolio. The Sortino Ratio was 1.26, indicating better risk-adjusted returns with a focus on downside volatility.
Correlation: The portfolio demonstrated a lower correlation of 0.96 with the stock market, indicating a somewhat lower alignment with overall market trends compared to the 60/40 Portfolio.

The 58/40/2 Portfolio outperformed the 60/40 Portfolio in terms of both raw returns and risk-adjusted metrics. The inclusion of Bitcoin in the portfolio contributed to higher annualized returns and better risk-adjusted returns, particularly evident in the higher Sortino Ratio.
Despite the higher returns, the 58/40/2 Portfolio also exhibited slightly higher volatility, as seen in the higher standard deviation. Investors should consider this trade-off between risk and return based on their risk tolerance and investment objectives.
The lower correlation of the 58/40/2 Portfolio with the stock market suggests that the inclusion of Bitcoin introduced some diversification benefits, potentially helping mitigate overall portfolio risk.

2014–2017

During the period from 2014 to 2016, the global financial markets experienced various dynamics. In 2014, markets saw overall positive performance, with major indices reaching new highs. However, concerns about slowing global economic growth, particularly in China, led to increased volatility. In 2015, markets faced increased uncertainty, driven by factors such as the devaluation of the Chinese yuan, falling commodity prices, and anticipation of potential interest rate hikes by the U.S. Federal Reserve. The latter half of 2015 and early 2016 witnessed heightened market turbulence, with a notable correction in many equity markets.

The central banks, including the Federal Reserve, played a role in attempting to stabilize markets through accommodative monetary policies. By mid-2016, markets showed signs of recovery, supported by improving economic indicators and central bank interventions.

60/40 Portfolio:

End Balance: The initial investment of $10,000 grew to an end balance of $13,706.13, with an inflation-adjusted end balance of $12,956.94.
Annualized Return (CAGR): The portfolio achieved an annualized return of 8.20%, or 6.69% when adjusted for inflation.
Risk Metrics: The standard deviation, a measure of volatility, was 5.86%, indicating relatively low volatility. The maximum drawdown, representing the peak-to-trough decline, was -5.22%.
Risk-Adjusted Metrics: The Sharpe Ratio was 1.33, reflecting a favorable risk-adjusted return. The Sortino Ratio was notably high at 2.51, indicating superior risk-adjusted returns with a focus on downside volatility.
Correlation: The portfolio demonstrated a high correlation of 0.98 with the stock market, indicating a strong alignment with overall market trends.

58/40/2 Portfolio:

End Balance: The initial $10,000 investment grew to an end balance of $14,711.54, with an inflation-adjusted end balance of $13,907.39.
Annualized Return (CAGR): The portfolio achieved a higher annualized return of 10.13%, or 8.60% when adjusted for inflation, compared to the 60/40 Portfolio.
Risk Metrics: The standard deviation was 6.25%, indicating slightly higher volatility than the 60/40 Portfolio. The maximum drawdown was -5.27%.
Risk-Adjusted Metrics: The Sharpe Ratio was 1.54, indicating strong risk-adjusted returns. The Sortino Ratio was notably high at 3.01, indicating exceptional risk-adjusted returns with a focus on downside volatility.
Correlation: The portfolio demonstrated a lower correlation of 0.95 with the stock market, indicating a somewhat lower alignment with overall market trends compared to the 60/40 Portfolio.

Both portfolios exhibited positive performance, with the 58/40/2 Portfolio outperforming the 60/40 Portfolio in terms of both raw returns and risk-adjusted metrics. The inclusion of Bitcoin in the 58/40/2 Portfolio contributed to higher returns, as evidenced by the higher annualized returns and superior risk-adjusted measures, particularly the Sortino Ratio. Despite slightly higher volatility, the 58/40/2 Portfolio managed to achieve better risk-adjusted returns, especially in mitigating downside risk, as indicated by the higher Sortino Ratio. The lower correlation of the 58/40/2 Portfolio with the stock market suggests that the inclusion of Bitcoin introduced some diversification benefits, potentially helping mitigate overall portfolio risk.

Conclusion

In summary, the 58/40/2 portfolio, incorporating a 2% allocation to Bitcoin, consistently outperformed the traditional 60/40 portfolio across various metrics during the tested 4-year periods. The Compound Annual Growth Rate (CAGR) surpassed that of the 60/40 portfolio, and both Sortino and Sharpe ratios were higher, indicating better risk-adjusted returns acrossed all periods tested. On the other hand, the standard deviation was slightly higher, suggesting a small marginal increase in volatility. Furthermore, it is crucial to note that the 58/40/2 portfolio experienced slightly higher maximum drawdowns in times of turmoil for financial markets. Moreover, the inclusion of Bitcoin in the portfolio, as evidenced by a slightly reduced market correlation, suggests a modest decrease in alignment with traditional assets. While there is a discernible shift, it’s important to note that the reduction in market correlation is not significant. Overall, incorporating a conservative allocation to Bitcoin has enhanced Compound Annual Growth Rate (CAGR), Sortino ratio, and Sharpe ratio. This improvement can be attributed to the unique risk-return profile of Bitcoin, which, even in a conservative allocation, introduces a source of potential growth without significantly compromising the overall risk-adjusted returns. This strategic inclusion allows for a more balanced portfolio, harnessing the benefits of Bitcoin’s performance while maintaining a conservative approach to risk management.