Crypto is a new asset class with a host of potential opportunities. Since its mainstream debut in 2017, the crypto space has evolved tremendously, mainly:
- Crypto has gained more legitimacy from growing investments from financial institutions, updated regulations, and increasing user adoption.
- Cryptos continue to churn. Many of the top coins from the 2017 to 2018 market cycle are now outdated compared to newer coins with better tech and use case potential.
- The development of decentralized finance (DeFi), NFTs, the metaverse, and the rest of the Web3 ecosystem have created utility from blockchain and attracted millions of users.
The market is still hype-driven and full of swindlers, much like a Wild West saloon. Following a historic bull run, the crypto market was rocked by multiple scandals this year, such as the collapse of Terraform Lab’s Luna/UST, Voyager, Celsius Network, among others, leading to an equally historic crash.
For investors, pondering how much to invest in crypto can conjure feelings of regret, FOMO, or a mix of the two. Let’s dive into how you can decide how much of your portfolio should be in crypto.
- Using key investment fundamentals like the risk-return tradeoff and diversification can help you learn if crypto is right for you and how much you should hold.
- The consensus among studies and advisors finds that holding 1%-5% of your portfolio in crypto has the potential for high returns and limited downside risk.
- Investing in crypto works best when you remove emotion from your strategy and take steps to secure your holdings.
Use Investing Fundamentals To Guide Your Crypto Decisions
As alternative investments go, crypto is one of the most volatile. Using an approach that removes emotions from your investing process can save you money, time, and headaches.
The good news is that drawing upon fundamental investing principles will help you make decisions and build a portfolio (collection of invested assets) that aligns with your goals.
In investing (and life), you get more back when you put more at stake. If you are willing to risk more, you can potentially earn more in the long-term. Putting your money into assets like stocks or real estate can net you a higher return than bonds or CDs. You exchange some stability for volatility and the potential to earn a better return… or a larger loss.
In crypto, looks can often be deceiving. A coin or app can easily promise you a very high return for taking on supposedly little risk, but that’s wishful thinking. Crypto investors often do not have access to proper info to understand the risk they accept for the returns they expect. Just ask the people who invested in Celsius or other crypto lenders…like me!
To invest in crypto means you are placing a bet on the future success of emerging technology. If you choose to invest in it, it’s best to use money that you can afford to lose.
How much are you willing to wager and be okay with losing?
Your risk tolerance is your understanding of how much money you can put into risky investments and still sleep well at night. It lives at the intersection of your emotions, needs, and risk appetite.
- Emotions having the self-awareness to understand how you respond in extreme market events, especially as crypto is prone to such moves (e.g., 50% downswing) will tell you a lot about your investing preferences. In a downturn, do you buy the dip or panic sell?
- Needs knowing your financial goals and present needs will help you calculate how much money you can put toward risky assets without damaging your financial health and well-being. Investing should never compromise your financial situation.
- Risk Appetite how much money are you okay with gambling with, such that if you couldn’t get it back, you would be okay both mentally and materially?For some, this figure might be $0, $1,000, or even $10,000, but it depends on your personality and overall financial situation. Not everyone is comfortable with huge losses in their portfolios, but this is common with crypto due to its seasonal cycles. To participate in crypto, you have to be very aggressive with risk and comfortable with having less info and transparency. It’s not uncommon for first-time or even experienced crypto investors to get burned and come around wiser the next round (or even completely abandon it).
Diversification — Across Asset Classes
Now that we’ve covered accepting risk, let’s talk about managing it. The best way is to diversify your portfolio, or not put all your eggs in one basket.
In this context, it means investing across asset classes, such as bonds, gold, and cash.
Divvying up your investments helps you become less likely to take major losses and sets your portfolio up to thrive in different market environments. This breakdown, like the one above, is an asset allocation. Your asset allocation reflects your risk tolerance and desired risk/return tradeoff.
Common examples of moderately aggressive, diversified portfolios include:
- 60/40 60% in stocks, 40% in bonds
- 3-Fund 1 index fund for domestic stocks/international stocks/bonds
My Investing Strategy with Traditional Investments and Crypto
As I’m in my 20s, I have a more aggressive investing style so I allocate my investments across stocks, index funds, and crypto. I started with a foundation in long-term, index fund investing to take advantage of compound interest. I use my leftover funds on select cryptos and stocks to make calculated bets.
As the markets have become bearish, I reset my asset allocation by buying more into I-bonds and index funds to increase my return while limiting my downside risk.
Understanding Crypto Allocation Recommendations
I’ll draw from expert guidance and studies to highlight how crypto can be a part of your portfolio. I focus mainly on BTC and ETH as they have more price history compared to other coins and their effects on portfolio asset allocations have been studied. These studies referring to crypto in portfolios are skewed by the strong performance of leading coins, such as BTC and ETH from 2014 to 2021.
Your Investing Game Plan… Asset Allocation with Crypto!
The good news is that holding only
1% to 5% of your portfolio in crypto
is enough to optimize your returns. If you invest in this range, you strike a balance between the risk you take on and the potential for above-average returns. How do we know this?
The founder of the Digital Assets Council for Financial Professionals, Ric Edelman, argues that a 1% allocation in crypto can materially improve a portfolio as an investor can see a 2x return if the crypto market does well…but not suffer in a crash. Edelman used Bitcoin’s history (from 2017 onward) and found that:
- a typical 60/40 portfolio would produce annual average returns of 7%
- taking 1% of that to Bitcoin (59/40/1) brought first-year returns of 22% and second-year returns of 15%
- even if the crypto market crashes, the first year would see a 6% return and the second year would see 13.4%
Plus, a 2019 Yale study that looked at BTC, ETH, and XRP found that having 4-6% of your investments in digital currencies produced strong returns. The study’s author, Professor Aleh Tsyvinski, used Sharpe’s Ratio (a measure of an asset’s volatility) on the three digital assets and found a higher potential for return despite their high risk. He reports that a minimum allocation of 4% to Bitcoin helps with portfolio allocation and performance.
Overall, if you can afford it, putting a small percentage of your funds into the right coins can lead to a large upside with little downside risk.
The Financial Advisor’s Approach
Using modern portfolio theory, a financial planner would recommend a client allocate a material portion of their investment portfolio to a particular asset class. This means that each allocation should have a meaningful impact — which is why the usual base is at least 10%.
However, the wild nature and novelty of crypto would lead an advisor to suggest putting in as much as you feel comfortable with, with money you can afford to lose.
Common Digital Assets Investment Allocations
Investors commonly hold one or both of the “blue-chip” coins — BTC and ETH. They value BTC for its decentralized, immutable ledger and ETH for its growing role in Web3. They also treat the high market caps of these coins as signs of their dominance and resilience in the market.
Others investors like to hold altcoins with their blue chips, placing larger bets on niche projects for higher potential returns.
The Bottom Line
There is no set amount for how much of your portfolio should be in crypto. If you want to participate in crypto, the best amount for you is the one that matches your risk tolerance, time horizon, and goals. Despite crypto’s uncertainty, a person can rely on time-tested investing principles to help make difficult decisions. No matter what you decide to do, ensure that crypto acts as a part of your overall portfolio and not all of it.
As of this article’s writing in November 2022, the crypto market has been in a downward trend due to the failure of key CeFi companies (e.g., Three Arrows Capital, FTX). These failures are due to unethical behavior and the lack of transparency within the ecosystem. The effects are still ongoing, casting uncertainty on crypto’s future and adoption.
I’ve been in crypto for some time, but I got caught in Celsius and narrowly avoided the FTX implosion. I know others who have been affected.
These events have given the crypto space a “hard reset” and revealed the worst aspects of the industry. Hopefully, the future will focus on creating true value, feature fewer insane promises, and more guardrails to protect everyday investors. A cleaned-up crypto industry can better deliver on the promise of Web3 and a more decentralized Internet — something worth investing in.
FAQs — Frequently Asked Questions
Q: Why don’t financial advisors talk about crypto?
Finance is a conservative institution that has only recently warmed up to the crypto space. Many advisors are not literate in blockchain or crypto and feel they should not advise on it. Your average financial advisor has done well by sticking to what they know by recommending their clients stick with traditional assets like equities and bonds, using regular allocations like a 60-40 portfolio. The 10-year performance of the stock market is a good indicator of why.
However, 22% of Americans now hold crypto in some form, meaning the pressure is mounting on finance people to become crypto literate — but until then it’s best to study it yourself.
Q: How should I split my crypto portfolio?
To diversify your crypto portfolio, consider allocating 80% of your funds to more stable, crypto “blue chips” and 20% to riskier altcoins. For instance, a strong 80/20 crypto allocation could look like — BTC -40%, ETH 40%. and SOL 20%.
Q: How much profit should I take in crypto?
Look at the percentage of profits on your investments and consider your goals and risk tolerance. Many traders seek a 50% return before taking profits, while others seek larger multiples like 200%. You can set whatever target you want to take profits at.
Note that any opinions expressed in this article do not necessarily reflect an endorsement of a specific project or platform.