According to Timothy Burgess, a well-balanced portfolio that include cryptocurrencies like bitcoin or ether may provide better returns and a higher Sharpe ratio than typical portfolios composed only of stocks, bonds, or other assets.
From being a niche investment in recent years, cryptocurrencies are becoming a common digital asset class that is being included into diverse portfolios more and more. Including a cryptocurrency allocation in a portfolio might be a very attractive approach for investors who want to increase the risk-adjusted returns. Compared to conventional portfolios composed only of stocks, bonds, or other assets, a well-balanced portfolio that include cryptocurrencies like bitcoin or ether may provide better returns and a higher Sharpe ratio. Let’s examine the reasons for this and examine measures that show the benefits of incorporating cryptocurrency from a risk/return standpoint.
The expansion of cryptocurrency markets has been phenomenal, with gains far surpassing those of traditional asset classes. For instance, during the last ten years, bitcoin has produced an annualized return of 230%, whereas the S&P 500 has produced an annualized return of just 11%. In its early years, Ether, another well-known cryptocurrency, has also generated triple-digit yearly growth rates. These digital assets offer investors the possibility of much larger profits despite their volatility, especially during times of market boom.
Investors can profit from part of these profits by adding a modest portion of cryptocurrency to a diversified portfolio, say between 2% and 10%. According to historical statistics, portfolios with even a little amount of cryptocurrency exposure have performed better overall. A standard 60/40 portfolio, which consists of 60% equities and 40% bonds, may have yielded an annual return of 8% over the last ten years. However, if a comparable portfolio had included 5% bitcoin, the annualized returns might have been closer to 12% or more without a notable increase in risk.
The advantage of the Sharpe ratio: improved risk-adjusted returns
Despite their well-known volatility, cryptocurrencies can nonetheless increase risk-adjusted returns when included in a portfolio and handled properly. The Sharpe ratio, which calculates the return per unit of risk assumed, is one of the most important indicators to evaluate this. Better risk-adjusted returns are being produced by the portfolio when the Sharpe ratio is greater.
Portfolios with a minor cryptocurrency exposure outperform traditional portfolios by 0.5 to 0.8 points when comparing data from 2015 to 2023. For example, adding 5% bitcoin to a typical portfolio may increase its Sharpe ratio from 0.75 to around 1.2, indicating an optimal balance between risk and return. Because the price fluctuations of cryptocurrencies sometimes have little to no connection with those of traditional asset classes, they provide superior diversification, which is why the Sharpe ratio has increased.
Diversification as a means of risk mitigation
Another well-known use of cryptocurrencies is to act as a hedge against conventional financial market downturns and inflation. Bitcoin is sometimes compared to digital gold because of its limited availability. In times of economic instability or inflation, holding cryptocurrency in a portfolio might help offset losses in more conventional assets like stocks or bonds.
Therefore higher Sharpe ratios show that including cryptocurrency into a portfolio may greatly increase returns and better risk-adjusted performance. Even though this digital asset class is inherently volatile, investors looking to maximize their risk/return profile may benefit from a smart allocation.
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