Over the past year, portfolio diversification has been an ardent topic of discussion. The rise of Bitcoin led to various debates about its inclusion in present-day investment holdings. While many traditional analysts are skeptical of a massive allocation for the crypto, some Bitcoin proponents would come across as over-ambitious putting 100% of their capital in BTC.
None of the above is correct when it comes to investing in Bitcoin, but there might be a way to incorporate a popular stock, a precious commodity, and Bitcoin together, and enjoy the best of all scenarios; be it profits or losses.
Bitcoin-S&P 500-Gold: The perfect concoction?
Comparisons have been off-the-charts for the above trio of assets since the start of 2020. After the black swan event in March 2020, correlations between them have been fervently discussed but from a long-term perspective, the inclusion of all three of them makes sense.
According to a recent Ecoinometrics report, rebalancing is key in order to maintain consistent profits from these assets. In order to understand the concept, let’s say you have $1000 dollars invested in Bitcoin and Gold during the start of the month, with an equal 50-50% allocation. At the end of the same month, the growth might lead to 75% allocation for BTC and 25% for Gold.
Then, a proper re-balancing is carried out by selling some BTC and buying some amount of gold, to allocate a portfolio of 50-50% again. The action is almost like a re-set and its importance will be discussed further.
Why is re-balancing important if an asset is surging better than the rest?
Over the past 8 years of historical data analyzed, this is how the scene looked like if 100% capital went into one asset.
- 100% BTC, 0% Gold, 0% S&P 500
Annualized returns 100%, largest drawdown: 89% - 100% Gold, 0% BTC, 0% S&P 500
Annualized returns -1%, largest drawdown 42% - 100% S&P 500, 0% Gold, 0% BTC
Annualized returns 9%, largest drawdown 37%
So while going all-in with Bitcoin looks extremely lucrative, it also springs the largest drawdown and in that situation, the ‘mental/emotional’ situation is more difficult to deal with than the losses.
Hence, an appropriate amalgamation of Bitcoin, stocks leads to a reduced size of drawdown, while keeping the risk-adjusted return on the same level.
A 34%-33%-33%; Better annualized Returns-Less Risk?
The idea of an equally distributed portfolio is with regard to taking advantage of all scenarios.
Source: Ecoinometrics
Therefore, when it comes to higher annualized returns, investing higher in Bitcoin would definitely be more profitable. But such returns remain high on the chart only for a lower period of time and dealing with such market volatility may lead to stressful re-balancing.
Source: Ecoinometrics
An equal allocation starts to make sense when Bitcoin faces massive drawdowns and S&P 500 and Gold balances out some of the losses in risk-adjusted returns.
It is important to understand that Bitcoin is still at an early adoption phase hence the correlation between S&P 500, Gold will not be similar over the long-term. However, managing the gains over the long-term is more important than scalping a short-term outlook. Rebalancing helps smoothen the returns by mitigating some of Bitcoin’s downside volatility.
