With Bitcoin (BTC -0.59%) hitting new all-time highs and breaking through the $100,000 price level in December, it's perhaps no surprise that many investors are exploring the pros and cons of adding this cryptocurrency to their portfolios. But just how much of your portfolio should you be allocating to Bitcoin?
The percentage might be lower than you think. According to BlackRock (BLK -0.96%), the $11.5 trillion asset management firm behind the most popular spot Bitcoin ETF (the iShares Bitcoin Trust), the optimal allocation for most investors is still just 2%.
Why a 2% Bitcoin allocation makes sense
BlackRock started by considering a typical 60/40 portfolio (60% stocks, 40% bonds). It then modeled the impact of adding progressively higher amounts of Bitcoin to that portfolio, to see how it changed its overall risk-reward profile. BlackRock considered three possible allocations for Bitcoin: 1%, 2%, and 4%.
Image source: Getty Images.
If you allocate 1% of your portfolio to Bitcoin, you will benefit from overall portfolio diversification. However, there may not be enough upside potential to justify adding Bitcoin to your portfolio, given the inherent risk and volatility of cryptocurrencies.
If you allocate 4% of your portfolio to Bitcoin, then the overall risk of your portfolio increases significantly, and it starts to be levered too highly to crypto. In other words, your stocks may be doing great, but one bad year from Bitcoin could spoil it all.
A 2% allocation offers the best of both worlds in Blackrock's view: It provides enough diversification to lower your overall risk profile, and it also provides enough upside potential to justify adding it to your portfolio. With a 2% allocation, says BlackRock, you're basically taking on the same amount of risk as if you were investing in a "Magnificent Seven" tech stock, with the potential for higher returns.
As BlackRock points out, those higher returns are possible because of Bitcoin's growing global adoption. The more that Bitcoin tips into the mainstream, the higher its price should go. That's because the total lifetime supply of Bitcoin is capped at 21 million coins, and nearly 20 million coins are already in circulation. Any increase in global adoption should send Bitcoin demand soaring. Rising demand, combined with a fixed supply, should send the price of Bitcoin higher as well.
What is the optimal Bitcoin allocation?
At this point, you might be scratching your head. A 2% allocation to Bitcoin sounds rather low, considering that some crypto investors -- such as Bitcoin evangelist Michael Saylor of MicroStrategy -- are advocating that you go all-in on Bitcoin. And, earlier this year, Cathie Wood of Ark Invest concluded that the optimal allocation for Bitcoin was 19.4%.
So what gives? The optimal Bitcoin allocation really depends on you. How much risk are you willing to take on? And how bullish are you about Bitcoin's future growth prospects?
If you think that Bitcoin is eventually going to replace the U.S. dollar and become the most important asset in the world -- as Saylor does -- then you might want to boost your allocation. You could also be inspired to increase your Bitcoin allocation if you think that Bitcoin has a good chance of outperforming tech stocks over the long haul -- as Wood does.
If, on the other hand, you think that Bitcoin is still too risky and volatile, then you might want to dial back your allocation to 1% or lower.
From my perspective, the 2% allocation recommended by BlackRock is the "Goldilocks" number: It's not too small, and it's not too big. You're taking on essentially the same amount of risk as investing in a Magnificent Seven tech stock, but with the potential for even richer rewards. For investors with a 60/40 portfolio, this approach makes a lot of sense. It might be less reasonable if you have a riskier portfolio (say, an 80/20 portfolio).
Impact of the Trump presidency
As BlackRock pointed out in its report, investors should keep in mind the potential impact of a Trump presidency when making projections about Bitcoin's future upside potential: "The run-up to record highs after the recent U.S. election reflects investors upping the chance of greater adoption given President-elect Donald Trump's statements and personnel picks supportive of cryptocurrencies."
So keep your eyes on what's happening in Washington, D.C. If the Trump White House follows through on pro-Bitcoin promises made on the campaign trail -- such as the creation of a strategic Bitcoin reserve -- then the rate of global Bitcoin adoption might skyrocket over the next four years. And that, in turn, could lead to an entirely new evaluation of what the optimal Bitcoin allocation should be.
