Paperstreet | Intelligence — Time, Diversification & the Volatility of Returns

What happens when you put 2% of Bitcoin into a traditional portfolio?

When it comes to investing for retirement, Americans are falling behind.

According to Northwestern Mutual’s 2018 Planning & Progress Study, which surveyed 2,003 adults, 78 percent of Americans say they’re ‘extremely’ or ‘somewhat’ concerned about not having enough money for retirement. Another 66 percent believe that they’ll outlive their retirement savings. Even more concerning was that 21% of respondents stated that they had saved nothing.

Another report from the Economic Policy Institute (EPI), using 2013 data, looked at the mean and median retirement savings of working-age families, which it defines as those with wage-earners between 32 and 61 years old. The mean retirement savings for these families is $95,776 in 2013 dollars. The median, which is typically a better gauge, is just $5,000.

A hypothetical $100,000 investment increased in value by over $514,000 in ten years, versus an increase of $175,000 for stocks/bonds… all by investing just 2% in Bitcoin.

With many experts forecasting the 10 year bull market in public stocks coming to an inevitable end soon, the opportunity for investors to kick-start their nest eggs seems in the next five years is unlikely.

However, over the past decade, the emergence of digital assets, or cryptocurrencies, may be creating such an opportunity.

Have you ever wondered what impact putting 2% of your overall investment portfolio in Bitcoin might have on return and volatility over time?

On its own, 2% isn’t enough to wreck anyone’s nest-egg. Worst case scenario, if the entire investment is lost, the investor still has 98% of what they start with. Given Bitcoin’s low correlation to stocks and bonds, it is possible that the 2% loss would be offset by gains in the other asset classes.

On the other hand, data shows that a 2% investment in Bitcoin can potentially have enormously positive effects on a portfolio.

The table above ^ shows the annual average total return of stocks and bonds form 1978 to 2018. If you’re not familiar with “total return,” it’s the % increase/decrease in the value of the asset + the dividends/interest earned by that asset in one year. For example, a stock that goes up 5% in a year AND issues a 2% dividend that year would have a total return of 7%.

As you can see, the total return of stocks (S&P500) has been a pretty healthy 11.7% per year. Bonds are slightly lower at 7.2%, which is understandable given that investors expect lower returns when taking lower risk.

Despite the awful year Bitcoin (-73%), stocks (-4%) and bonds (0%) had in 2018, a 70/30 portfolio w/ 2% in Bitcoin performed only down 4% overall.

A 70/30 portfolio is a diversified portfolio where an investor puts 70% of their assets in stocks and 30% in bonds. This allows the investor to reap higher returns without taking substantially more risk.

Finally, we’ve added a 70/30 portfolio where 2% of the assets were invested in Bitcoin (68.6% stocks, 19.4% bonds, and 2.0% Bitcoin). Despite the volatility of Bitcoin, by investing only 2%, an investor nearly doubled their annual average total return.

A $100,000 investment increased in value by over $514,000 in ten years, versus an increase of $175,000 for stocks/bonds… all by investing just 2% in Bitcoin.

What about the volatility of Bitcoin? Won’t it destroy my portfolio?

This chart shows historical returns by holding period for stocks and bonds, rebalanced annually, over different time horizons. The bars show the highest and lowest return that you could have gotten during each of the time periods (1-year, 2-year rolling, 5-year rolling and 10-year rolling).

This means that, since 1977, no investor holding stocks has ever lost more than 37% in a single year, assuming they held the S&P500.

Additionally, since 1977, no investor has ever earned less than 2% per year holding bonds for at least five years, assuming they rebalanced annually.

Now let’s evaluate the same metrics for a 70/30 portfolio.

As you can see, a 70/30 portfolio isn’t nearly as volatile as stocks. The highs aren’t as high. Similarly the lows aren’t as low. In fact, since 1977, no investor with a 70/30 portfolio has ever lost any of their portfolios value over a five year period, assuming annual rebalancing.

While bonds performed exceptionally well during the 20s years since the interest rate bubble of the 1980s, most experts expect their performance to be much lower over the next ten years than is demonstrated in this chart.

This is why many investors choose a 70/30 or similar portfolio. You achieve a lot of the return of stocks without as much volatility.

Finally, let’s look at what happens when we add 2% of Bitcoin to the 70/30 portfolio…

The numbers speak for themselves. While there isn’t sufficient data yet to show 10-year rolling results, 5-year rolling results range from a low of 9% per year (53% overall growth) to 31% per year (285% overall growth).

Despite the awful year Bitcoin (-73%) and poor year stocks (-4%) and bonds (0%) had in 2018, a 70/30 portfolio w/ 2% in Bitcoin only performed down 6% overall.

The 1-year and 2-year upsides are enormous, with the portfolio achieving a 134% gain in 2013 alone.

Summary

It is a clear that including a small piece of Bitcoin in one’s portfolio can have significant benefits. However, it is still a very new asset class and, according to some research, the correlation between Bitcoin and stocks has been increasing.

Investors who are interested in investing in Bitcoin should consult with a professional Financial Advisor. Additionally, investors investing in Bitcoin and any other digital assets should understand that they are extremely volatile and an investment may result in complete loss of principal.

Investors should also understand that past returns cannot predict future results.


Source: Barclays, Bloomberg, FactSet, Federal Reserve, Robert Shiller, Strategas/Ibbotson, J.P. Morgan Asset Management, Coinmarketcap, Morningstar.

Returns shown are based on calendar year returns from 1977 to 2018. Stocks represent the S&P 500 Total Return. Bonds represent the Bloomberg Barclays US Aggregate Bond Total Return Index.

Growth of $100,000 is based on stock and bonds annual average total returns from 1977–2018 and Bitcoin annual average total return from 2011–2018.

Paperstreet | Intelligence — Data as of December 31, 2018.


Dave Younts is a Series #7/66 FINRA registered Financial Advisor and extensively studied finance and investments at Duke University’s Fuqua School of Business while completing his MBA. He has been registered with FINRA since 2013. He serves as Chief Compliance Officer for Paperstreet. At the time of this writing, Dave Younts owned Bitcoin in his portfolio. Prior to this, he was a Financial Advisor at Stifel Financial Corp. and managed over $300m in investible assets as part of a small team in Charlotte, NC.