How even a tiny amount of bitcoin could net you massive returns

Much has been made about bitcoin and digital assets, particularly recently following its stellar run since Donald Trump’s return to the White House. However, given its volatile performance history, what’s less commonly discussed is how it fits into a traditional investment portfolio containing equities and bonds.

In the last year, bitcoin has made some significant steps forward as institutional and corporate adoption of digital assets continues. The launch of spot bitcoin ETFs in the United States improved clarity around regulation, and the take-up of adjacent use cases such as stablecoins have all given investors more confidence in digital assets.

Bitcoin has often been seen as an outlier asset for enthusiasts and devoted investors. But increasingly, it has a place in traditional portfolios.Credit: Getty

However, while there have been some meaningful steps forward in terms of adoption, digital assets remain volatile with a penchant for becoming susceptible to hype – begging two questions, is it worth considering an allocation to bitcoin within a diversified investment portfolio? And if so, how large should that allocation be?

In short, historical data suggests that a small allocation to bitcoin has the potential to deliver meaningfully higher returns without materially increasing risk at a portfolio level.

But as that allocation increases the marginal improvement in risk-adjusted returns starts to dissipate. So, like many things in life, it’s possible to have too much of a good thing, and any allocation to bitcoin should be sized accordingly.

When it comes to building an investment portfolio, the main game remains diversification across asset classes – such as Australian and international equities, bonds, cash and commodities including gold.

Adding a 2.5 per cent bitcoin allocation with quarterly rebalancing can improve the cumulative return of a portfolio to 187 per cent.

The other important consideration is time horizon and risk tolerance. For example, a person approaching retirement might have a higher allocation towards defensive assets such as fixed income compared to an accumulator investor with a longer time horizon.

In partnership with Bitwise, we looked at the simulated investment implications of adding bitcoin to a hypothetical Australian investor’s portfolio with a 70/30 split to equities and bonds – that comprises a 35 per cent allocation to Australian equities, a 35 per cent allocation to international equities, and a 30 per cent allocation to Australian bonds.

As you’d expect, adding an allocation of bitcoin to a portfolio boosted returns over the 10-year period between 2015 and 2024. However, the size of a bitcoin allocation did have some meaningful implications, particularly beyond 5 per cent where volatility and drawdowns increased.

During the period between 2015 and 2024, a 70/30 portfolio without a bitcoin allocation returned 123 per cent on a cumulative basis, assuming quarterly rebalancing, which translates to an annualised return of 8.37 per cent per year.

By comparison, however, adding a 2.5 per cent bitcoin allocation with quarterly rebalancing would have improved the cumulative return of the portfolio to 187 per cent, or 11.15 per cent per year.

This would have been achieved without major changes in either the portfolio’s volatility (8.68 per cent p.a. with bitcoin versus 8.36 per cent p.a. without) or its maximum drawdown (21.18 per cent with bitcoin compared to 21.02 per cent without).

At the same time, a 5 per cent allocation to bitcoin would have boosted the cumulative return of the portfolio to 266.81 per cent (or 13.88 per cent p.a.). However, at this level, portfolio volatility sat higher at 9.51 per cent while the maximum drawdown was 21.42 per cent.

Beyond a 5 per cent allocation to bitcoin, the hypothetical portfolio became a lot more volatile and the maximum drawdown was higher – as were returns. At a 10 per cent allocation to bitcoin, returns were higher at 19.2 per cent p.a., but volatility was 12.04 per cent and the maximum drawdown was 22.55 per cent.

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While past performance is no guarantee of future results, and the above example is provided for illustrative purposes only, it’s a worthwhile lesson about the importance of asset allocation when building a portfolio.

It’s always been our view that bitcoin is an extremely volatile asset class and is best considered (at most) for a minimal allocation – noting the increased volatility and maximum drawdowns associated with bitcoin allocations beyond 5 per cent.

The reality is most investors should hold their largest portfolio allocations in more established asset classes, such as Australian and international equities, bonds and possibly commodities such as gold, depending on their individual circumstances. Where appropriate, some investors then might wish to consider “getting off zero”, in terms of adding a small allocation to bitcoin in their portfolio.

In any case, over the long term, a well-rounded portfolio that takes advantage of the natural compounding power of the market with regular portfolio contributions not only serves as a powerful tool for long-term wealth creation, but also helps investors sleep well at night by turning down the noise associated with volatility.

Cameron Gleeson is senior investment strategist at ETF provider Betashares.

• Advice given in this article is general in nature and is not intended to influence readers’ decisions about investing or financial products. They should always seek their own professional advice that takes into account their own personal circumstances before making any financial decisions.

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