There’s a simple formula for adding crypto to your portfolio
2 min read
Imagine coming home and opening your fridge to find a jar filled with your favorite juice. After taking a sip, you realize that the kind soul who prepared the juice added too much water, and there’s not much you can do to fix it — removing water from juice is a complicated process. However, if instead the juice-maker was too stingy with water, you can simply dilute the juice with extra water and enjoy a perfect refreshing drink.
A similar phenomenon happens with the risk of financial assets. If an asset has too little risk, it is complicated to “remove water” and make it riskier, usually through leverage. On the contrary, if the asset is too risky, it is straightforward to dilute it with cash equivalents, such as short-term Treasury Bills, or T-Bills.
Crypto assets have emerged as a new asset class in the past 14 years. As they’ve gained popularity, debates have arisen about their role in a portfolio of traditional assets. The controversy largely stems from concerns about the level of risk associated with these assets, which is significantly higher than that of even the riskiest traditional assets.
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Just to give more color to these numbers, we can take the example of the traditional 60% equities and 40% bonds allocation. This portfolio returned 7.6% yearly in our analysis period with annualized volatility of 11.4%, resulting in a Sharpe ratio of 0.59. Using the formula, the final portfolio has 4% in crypto (0.17% + 6.40 x 60% = 4%), 6% in T-Bills (4% x 1.5 = 6%), 50% in equities (60% – 4% – 6% = 50%) and 40% in bonds. As expected, the volatility is the same as the original portfolio, but the return grew to 10.2%, leading to a Sharpe ratio of 0.82, 1.4 times greater.
As these simulations indicate, the discussion shouldn’t be around whether there is room for crypto in a traditional assets portfolio. Instead, we should be talking about how best to allocate to this asset class. The formula above summarizes a simple approach that delivers good results. If you’re still skeptical about investing in crypto, take a glass of your preferred juice with the right concentration of water and think about it while you drink.
João Marco Braga da Cunha is the portfolio manager at Hashdex. He obtained a master of science in economics from Fundação Getulio Vargas before obtaining a doctorate in electrical and electronics engineering from the Pontifical Catholic University of Rio de Janeiro.
This article is for general information purposes and is not intended to be and should not be taken as legal or investment advice. The views, thoughts and opinions expressed here are the author’s alone and do not necessarily reflect or represent the views and opinions of Cointelegraph.
