Does cryptocurrency belong in a retirement investment account? Should investors trade it in the short-term or buy and hold? How much money is too much to allocate to bitcoin or ethereum?
Cryptocurrencies are becoming an increasingly popular option in alternative investments, leaving many Americans wondering when — if ever — they should include this rising asset class in their retirement savings strategies. The answer is: it depends. Retirement planning must incorporate a wide variety of factors, including amount saved, life expectancy, income needs, and risk tolerance.
Still, a little risk in a retirement portfolio is to be expected, especially when the time horizon spans decades. In a Barron’s Live event on Aug. 11, MarketWatch reporters Alessandra Malito and Brett Arends spoke about if, when and how to include cryptocurrencies in retirement plans, and what to expect in the future.
To watch the full episode of this Barron’s Live session, click here. The session sparked dozens of questions from audience members about cryptocurrencies, including the ones below. Here’s what some Bitcoin-focused experts said.
What amount of your retirement savings should be allocated to cryptocurrency?
Whether or not there should be cryptocurrencies in a retirement portfolio depends heavily on the individual’s goals, time horizons, risk tolerance and assets, but it is one way to diversify investments. As an alternative, cryptocurrencies may be best as a small percentage of a portfolio. Below 1% is “too small to matter much” and above 5% substantially increases risk, so “1 to 5% is a sweet spot,” said Matt Hougan, chief investment officer of Bitwise Asset Management. “But everyone should make their own decision.”
One adviser explained alternatives in retirement portfolios as “the icing on the cake, not the cake itself.”
There are, of course, other investors who feel strongly about investing in cryptocurrencies in their retirement portfolios. Some client portfolios have between 5% to 25% of their accounts allocated to cryptocurrencies, said Chris Kline, chief operations officer of bitcoin IRA, a platform for investing in digital assets. Many of these investors prefer the tax advantages to investing in cryptocurrencies in an individual retirement account.
Here’s more information on the pros and cons of investing in cryptocurrencies through a self-directed IRA.
What are the compelling reasons to invest in it for retirement? And what are the compelling reasons not to?
There are two reasons to invest in cryptocurrencies for retirement, Hougan said. First, it has historically high returns over the last year, three years, five years and 10 years, but it is also not correlated to traditional stocks and bonds. “Adding noncorrelated assets can help with risk-adjusted returns,” Hougan said.
It’s also a “once in a generation disruptive technology that will have a big impact on the world,” Hougan added.
There are also potential tax advantages to investing in cryptocurrencies in a retirement account. These investments are taxed at capital-gains rates. If using a Roth IRA, investors pay taxes on their contributions up front and can then benefit from tax-free withdrawals at distribution, assuming they follow the rules accordingly.
But there are reasons not to include it in a retirement portfolio as well, aside from personal circumstances. “The biggest risk in cryptocurrency investing is behavioral risk,” Hougan said. The investment may be doing extremely well and hit a peak one month, but drop 50% and send investors into a panic to sell. “You have to have a long time horizon to hold an asset through periods of volatility.”
We heard how much of a retirement portfolio should be allocated to cryptocurrencies, but what percentage of an individual’s net worth should be allocated to this asset? And how would you subdivide that within bitcoin, ethereum and other alternative coins?
The suggestion to allocate a small percentage of a portfolio in alternatives like cryptocurrencies applies to retirement savings as well as general net worth, but when looking at net worth, it’s critical to focus on liquid assets. Net worth can include the value of one’s home, but when choosing how much to allocate to these investments, stick to just the money available to invest.
“In terms of how to allocate, I think the right approach is one of humility,” Hougan said. Technology evolves quickly — in just the span of 30 years, Americans have gone from not having internet in their households to being constantly connected to the web on their smartphones.
“It is hard to know how technology will develop, what the applications that matter will be and therefore where to invest,” Hougan said. When choosing how to spread out investments in cryptocurrencies, it might be best to stay broad and diversify as you would any asset class, and then underweight or overweight a particular type of crypto if you feel strongly about it.
Will the government regulate cryptocurrencies?
It is hard to tell when or how the U.S. government will take a closer look at regulating cryptocurrencies, but it is inevitable, Hougan said. That could be a good thing for the asset though, as it will push it into the mainstream for all investors to use more willingly, he said. “On the one hand, these regulations are cracking down on that and on the other side, they are creating a safe harbor and clear rules that unlock the potential to improve the ecosystem,” he said.
Should you trade cryptocurrency or buy and hold it?
“Trading any asset is difficult and one as volatile as cryptocurrency is that difficulty squared,” Hougan said. “So if it’s binary between trading and holding, you should hold it.”
That being said, it is very unlikely someone will hold on to an asset as volatile as certain cryptocurrencies for the long haul without making some changes to the portfolio or allocation. Just like with any other asset, these should be checked on at regular intervals and rebalanced when necessary. Portfolio allocations naturally move with price fluctuations of stocks and bonds, and without rebalancing, its trajectory toward specific goals can get off course.
“Crypto is becoming an institutional asset,” Hougan said. “Treat it like that.”
There are some investors who are choosing the set-it-and-forget-it approach, Kline said. “Trading can be done with anything but not something we see a lot of on our platform.”
How do you decide when to get out of these types of investments?
Hougan suggests having a “core thesis” when investing in this type of asset, such as how you think it will react in the market, and then altering your investment stance as you receive more information and news on it. There may be times when bad news strikes, causing the investment to plummet for a few days, but did it recover rapidly? What happened to the other assets in your portfolio during that time? “I would say not to react to the short-term,” he said.
What do you see for the future of cryptocurrency?
“Over the next five years, I think crypto will be a normal allocation in many investors’ portfolios,” Hougan said. “It will be increasingly regulated and adopted in the mainstream and an underpinning of how money moves in the world.”
There have been plenty of experiments within this market that have collapsed, but it has developed significantly over the last decade, so much so that politicians and Wall Street banks are debating its future. “The crypto market of today is not the same crypto of the past,” he said.