As cryptocurrency begins to appear in portfolios managed by institutional investors, this is a question that a growing number of individuals and their financial advisers are asking themselves.
The answer, according to advisers, is: It depends on factors such as an investor’s risk tolerance, financial capacity to absorb losses, and knowledge of the digital asset industry. Of those who use it for some clients, most recommend sticking to a small allowance, in the range of 1-2%.
In a recent survey of over 500 financial advisers conducted by organizations including the Financial Planning Association, nearly half of advisers said clients asked them to invest in cryptocurrencies, up from 17% in 2020. About 14% said they use or recommend it, up from less than 1% last year.
Bitcoin “is only 10 years old,” said Ric Edelman, founder of consulting firm Edelman Financial Engines LLC and investor in digital startups. “The focus has been on mining and trading. But now people are starting to take it to the next level of how to fit it into a larger portfolio.
Getting it right requires more than a high tolerance for risk.
Simon Tryzna, a financial advisor in San Francisco, says investors should have “an investment thesis” explaining why cryptocurrency is part of their financial plan. For example, he said that many of his tech-savvy clients believe that blockchain, the record-keeping technology behind bitcoin, can make the economy more efficient.
It is also important to research the growing range of products that allow everyday investors to add virtual currencies to their nest egg.
Because cryptocurrency is very volatile, adding even a small amount to a portfolio may require you to rearrange your asset allocation, thereby reducing exposure to other risky investments, including stocks, said Dan Egan. , vice president of behavioral finance and investing at Betterment, an online consulting firm. .
The following are other steps you should take before buying cryptocurrency.
Should I invest in crypto?
Cryptocurrency has the potential for big gains. Over the past year, the price of bitcoin has risen from just over $ 9,000 to nearly $ 32,000, after peaking at over $ 64,000 in April.
But Roger Aliaga-Diaz, head of portfolio construction at Vanguard Group, says that “it is a volatile investment subject to speculation that has no place in a prudent and well-balanced investment portfolio.”
Cryptocurrency is “largely unregulated and comes with considerable risk,” Aliaga-Diaz wrote in a recent article.
Since hitting a record high in April, bitcoin has lost about half of its value as China stepped up its crackdown on virtual currencies.
Yale University economist Aleh Tsyvinski, co-author of a 2018 study that concludes that institutional investors should invest around 1% to 5% of their portfolios in digital currencies, said individual investors at the Comfortable with alternative investments, such as gold and private equity, should consider adding crypto, too.
“If you have 5% alternatives, why not allocate 10% to crypto?” He said.
Because virtual currencies behave in a “completely different” way from stocks, bonds and other traditional investments, he said they can improve returns by rising when other assets fall. “It’s a very good investment for diversification.”
This is an argument that Mr. Aliaga-Diaz does not buy. He cautions against reducing allocations to stocks and bonds to make room for something that lacks “intrinsic economic value” and generates “no cash flow, such as interest payments or dividends, who can explain their prices ”.
“The prices of cryptocurrencies depend primarily on speculation about their adoption and use.”
John Piershale, an advisor in Crystal Lake, Ill., Said he advises against crypto to the vast majority of his clients, but has invested up to 2% in an exchange-traded fund that buys stocks of companies involved in blockchain technology. for a few clients who can withstand “large fluctuations in value”.
How much should I invest?
Those who think they can manage the risks of cryptocurrency should start small and buy a fixed amount at regular intervals until they reach the desired allocation, a strategy that reduces the chances of buying at a high market level.
Mr Egan said anything above 1% of a portfolio is “aggressive allocation” given that the cryptocurrency is only 0.5% of the value of global stocks and bonds.
“If you get really good and you have a strong commitment, you can go beyond 1%,” Mr. Edelman said. “But for most investors who build a diversified portfolio, 1% is enough.”
What do I need to buy to get exposure to cryptocurrency?
To buy or sell cryptocurrency, you can open an account on a cryptocurrency exchange such as Coinbase Global Inc. or a trading platform that offers it, such as Robinhood Markets Inc.
On Coinbase, an investor wishing to buy $ 100 worth of bitcoin would pay around $ 3.49 in fees, and potentially more with certain payment methods like debit cards. Robinhood charges no commission, but routes customer orders to the trading companies that pay it, a practice that critics say can prevent customers from getting the best prices.
Many large brokerage firms, including Fidelity Investments and Charles Schwab Corp., do not allow clients to buy or sell cryptocurrencies. But their clients can buy shares in trusts that invest in digital assets from companies like Grayscale Investments LLC. Grayscale Bitcoin Trust charges an annual fee of 2% and can trade at a premium or discount over the value of the bitcoin it holds.
Some advisers recommend buying stocks in companies like Coinbase or in ETFs that invest in digital asset companies.
Should I diversify among cryptocurrencies?
Some cryptocurrency fans prefer bitcoin. Others cite the dot-com shakeout as recommending an assortment.
Because cryptocurrency scams are common, do your research and only invest a nominal amount in unknown names, Egan said.
Is bitcoin part of my IRA?
Some clients who trade frequently want cryptocurrency in retirement accounts because they can reinvest the profits tax-free.
But because companies like Schwab and Fidelity do not allow IRA owners to purchase virtual currencies, these investors must use niche IRA providers specializing in alternative investments. Be aware of the fees charged by these IRA custodians.
Stick to companies regulated by federal or state banking authorities, Edelman said.
For an asset with significant earning potential, “the best place to hold it is in a Roth IRA,” said IRA specialist Ed Slott. Investors contribute after-tax money to these accounts, but the gains accrue tax-free. Money can be withdrawn tax-free as well, as long as a Roth owner is 59 and a half or older and the account has been open for at least five years.
It may make sense for some investors to hold cryptocurrency in a taxable account, Mr. Slott said. Provided you hold the investment for more than a year, you will pay the long-term capital gains tax rate of up to 23.8% when you sell at a profit and can offset the gains with capital losses. In contrast, with a traditional IRA, you will pay up to 37% income tax on your withdrawals.
How often do I need to rebalance?
While many advisers recommend taking a buy and hold approach, “set and forget” towards a diversified portfolio and rebalance desired portfolio allocations every year, it makes sense to watch more volatile holdings. such as digital currencies. often.
Mr Tryzna said a client who bought bitcoin and ether several years ago saw those holdings drop from 5% of his portfolio to 50%, before reducing the position to 20%.
Mr. Egan recommends using a consistent approach to rebalancing, such as doing it monthly or when your allocation deviates one percentage point from your target.
If you hold cryptocurrency in a taxable account, it might be a good idea to let the wallet drift a bit longer before rebalancing, unless you can offset taxable gains with losses, Egan said. He said Betterment tries to avoid sales that trigger the rate of short-term capital gains of up to 40.8% on assets held for a year or less.
—Alexander Osipovich contributed to this article.
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