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In recent years, Bitcoin and cryptocurrencies have become major players in the financial markets. However, their volatility presents significant challenges, particularly for retail investors seeking to balance risk and reward. With the rise of Bitcoin ETFs, investors now have a more accessible way to gain exposure to Bitcoin without struggling with the complexities of owning and securing the actual cryptocurrency.
As these ETFs grow in popularity—evidenced by the $556 million inflow on a single day in October 2024, their largest daily net inflow since June—there is a renewed focus on managing Bitcoin’s volatility alongside traditional assets like stocks and bonds.
Today’s retail investors can use Bitcoin ETFs to gain exposure to cryptocurrencies’ high growth potential while maintaining a stable and diversified portfolio. Key strategies include portfolio rebalancing, diversification, and prudent asset allocation to balance the inherent risks of Bitcoin’s volatility.
The Rise of Bitcoin ETFs
Bitcoin ETFs represent significant maturity and development in the crypto market. These funds expose investors to Bitcoin’s price movements without directly owning the asset. The first Bitcoin-linked ETF, ProShares Bitcoin ETF (BITO), launched in the U.S. in October 2021, marking a milestone in the regulatory acceptance of crypto-based financial products. As of 2023, several other Bitcoin ETFs have entered the market, offering different forms of exposure, from futures-based ETFs to spot-market-based ETFs.
The introduction of Bitcoin ETFs has made it easier for retail investors to include Bitcoin in their portfolios without dealing with the complexities of wallet management, security, and exchange transactions. These ETFs provide a familiar structure, much like traditional stock or commodity ETFs, allowing investors to trade Bitcoin in a regulated environment through conventional brokerage accounts.
Crypto Volatility: The Double-Edged Sword
While Bitcoin’s returns have been extraordinary, its volatility is notorious. Bitcoin’s price can swing wildly within hours. Bitcoin’s volatility today remains elevated. According to iShares, it is 3.9 and 4.6 times that of gold and global equities, respectively.
This extreme volatility presents a risk for investors, especially those with lower risk tolerance or shorter investment horizons. However, volatility also attracts many investors to Bitcoin and other cryptocurrencies—the potential for outsized gains sets Bitcoin apart from traditional assets like stocks and bonds. Managing this volatility without getting burned requires a disciplined approach, with risk management at the forefront.
Risk Management: Balancing Bitcoin ETFs With Traditional Investments
The key to managing the volatility of Bitcoin and other cryptocurrencies is through diversification and portfolio rebalancing. For retail investors, combining Bitcoin ETFs with traditional investments such as stocks, indexes, bonds, and commodities can help mitigate risk while retaining the potential for high returns.
Diversification: the foundation of risk management
Diversification is the bedrock of any solid investment strategy. By spreading investments judiciously across various asset classes with different attributes, investors can reduce their exposure to the risk of any single asset.
For example, if Bitcoin experiences a significant downturn, the negative impact on your investment portfolio can be cushioned by gains in other areas, such as stocks or bonds.
Asset correlations
One of Bitcoin’s advantages is its relatively low correlation with traditional assets. According to TradingView, Bitcoin’s correlation with the S&P 500 averaged about 0.17 over the past decade, meaning that the two assets do not tend to move in the same direction.
This correlation is lower than that of other alternative assets, such as the S&P Goldman Sachs Commodity Index, which demonstrated a correlation of 0.42 with the S&P 500 in the same period.
The low correlation makes Bitcoin a valuable diversification tool within a broader portfolio.
However, it’s essential to note that Bitcoin’s correlation with traditional assets tends to increase during periods of extreme market stress. Therefore, while Bitcoin can provide diversification benefits, it should not be viewed as a foolproof hedge.
Portfolio rebalancing: keeping risk in check
Given Bitcoin’s volatility, portfolio rebalancing is critical. Rebalancing involves adjusting the weight of various assets in your portfolio back to their target allocations. For example, if your portfolio consists of 60 percent stocks, 30 percent in bonds, and 10 percent Bitcoin ETFs, and Bitcoin experiences a significant price increase, it may now constitute 20 percent of your portfolio.
To maintain your desired risk profile, you must sell some Bitcoin ETFs and reinvest the proceeds into stocks or bonds to restore balance.
Regularly rebalancing your portfolio ensures that you don’t become overexposed to risky assets like Bitcoin during periods of rapid growth. Portfolios that are rebalanced at least once a year tend to exhibit lower volatility and higher risk-adjusted returns than portfolios that are left to drift.
Position sizing: the importance of allocation
Another critical aspect of proper risk management is position sizing. Most investors can capture potential upside while minimizing risk exposure by allocating a small amount to Bitcoin ETFs. Many financial advisors recommend limiting cryptocurrency exposure to approximately five percent of a diversified portfolio, depending on the investor’s risk tolerance.
For example, if an investor has a portfolio worth $100,000, a five percent allocation to Bitcoin ETFs would amount to $5,000. This exposure allows the investor to benefit from Bitcoin’s price appreciation while maintaining the stability of traditional assets like stocks and bonds.
Combining Bitcoin ETFs With Traditional Investments
By combining Bitcoin ETFs with traditional assets, investors can create a balanced investment portfolio with the potential for high returns while reducing overall risk. Here’s a breakdown of how different types of investments can complement Bitcoin ETFs in a diversified portfolio:
Stocks: growth and stability
Stocks are a crucial component of any investment portfolio. While they carry risk, particularly during market downturns, they have historically delivered strong long-term returns. The S&P index has a historic annualized average return of about 10.26 percent from 1957 to 2023.
Blue-chip stocks, which represent established companies with solid earnings and growth prospects, provide stability in contrast to the wild swings of cryptocurrencies.
Photo by Austin Distel on Unsplash
For retail investors, Bitcoin ETFs can be paired with traditional stock ETFs to build a diversified portfolio. While Bitcoin offers high potential returns, stocks provide long-term growth and lower volatility, helping to balance the risk.
Sites like Real World Investor can provide valuable information and insights on stock picks and other investment tips.
Bonds: income and safety
Bonds provide income and stability, making them a valuable counterbalance to riskier assets like Bitcoin. While bond yields have been historically low in recent years, they are still essential to a diversified portfolio, particularly for risk-averse investors or those nearing retirement.
U.S. Treasury bonds, for example, are considered some of the safest investments available, offering guaranteed returns with minimal risk of loss. Adding bond ETFs like the iShares Core U.S. Aggregate Bond ETF (AGG) can help stabilize a portfolio that includes Bitcoin ETFs, ensuring that investors still receive a steady income even if Bitcoin’s price plummets.
Commodities: hedging against inflation
Commodities like gold and oil have long been used as hedges against rising inflation and market volatility. While Bitcoin is often called “digital gold” owing to its limited supply and store-of-value (SoV) properties, it behaves very differently from physical commodities. Gold, for instance, tends to perform well during economic uncertainty, while Bitcoin can be highly volatile in similar conditions.
For investors looking to hedge against inflation, combining Bitcoin ETFs with commodity ETFs like the SPDR Gold Shares (GLD) or the iShares Silver Trust (SLV) can provide a measure of protection. These assets tend to possess low correlations with stocks and Bitcoin, offering further diversification.
Maximizing Returns Through a Combination of Traditional and Crypto Assets
The rise of Bitcoin ETFs offers retail investors a new way to gain exposure to the cryptocurrency market without directly owning the asset. However, Bitcoin’s volatility poses significant risks, making it essential to balance crypto exposure with traditional investments like stocks, bonds, and commodities.
By diversifying their portfolios, rebalancing regularly, and using strategies like dollar-cost averaging, investors can manage risk while maximizing returns in the age of Bitcoin ETFs.
As the financial landscape continues to develop, investors who embrace both traditional and novel instruments will be better positioned to navigate the challenges of the modern market and achieve long-term financial success.
