So, you’re on the path to appreciating that Bitcoin is a revolutionary technology that could alter the global economy. You agree that it has incredible upside price potential, but how much should you allocate? I’ve suggested before that a 1% of your investment portfolio allocation to bitcoin is a no-brainer because this makes almost no negative on portfolio volatility and drawdowns. But that’s largely an argument to get people off zero. There is range of potential allocations between 1% and 100%. How does one make this decision? This is a difficult question to answer. It’s deeply personal. I don’t know the answer for you, but I’d like to provide you with a framework to help you think through this important challenge. Everything I say here could and should be critiqued extensively depending on specific circumstances. You need to think through these variables and discuss them with your financial advisor or family to make the right decision for you.
Here are the 7 key factors to think through to build a foundation for position sizing:
Are you financially secure? Does your income cover your expenses? Is it easy to cover the interest expense on your debt? What about if interest rates rose by 2%? Do you have a cash buffer for emergencies? If you answer no to these questions, it doesn’t mean that you cannot invest into bitcoin. But you probably need to wade in tentatively with very small allocations to get a feel. In this case, only invest what you’re willing to lose. Learn about the technology first, make some positive financial changes, and move forward from there.
What are you trying to achieve with this money? Are you saving for a specific goal or just the future in general? Is the money for you, your wife, your children, or your extended family? The more people that are reliant on the money, the more pressure to make wise decisions. Pressure doesn’t imply that you shouldn’t invest in bitcoin, but it raises the importance of assessing your knowledge properly and position-sizing adequately given your knowledge.
Bitcoin is volatile. While the bull-markets are exciting, the pull-backs are terrifying and bear-markets can be depressing, if you’re not emotionally equipped. If your children’s college education fund drops by 70%, will this negatively impact your emotional health and your relationship with your loved ones? Do you know enough about bitcoin to digest this volatility and wait for the next bull-market without making a rash decision? You need to think this through before making any investment decision.
When do you need this money? Unless you are a very experienced trader, then you need to have a long time horizon when approaching bitcoin. A 1-year time horizon is an absolute minimum, in my opinion. If you need the money in less than a year, then save up first before looking to invest in bitcoin. If you need the money in 2-years, then you still need to restrain your allocation to below 5% of net worth.
Bitcoin’s price change has been positive over almost all 3-year rolling periods so for time horizons longer than 3 years, one can consider larger allocations. The longer the time frame, the higher the possible allocation. Ideally, you want to hold a bitcoin investment for 5 years+.
Age overlaps with time horizon (previous section) and risk tolerance (next section) but it’s worth repeating. The younger you are, the longer your time horizon. Plus, the longer you can ride out the volatility. Younger people tend to have more risk tolerance. If bitcoin drops by 70%, it doesn’t matter as much if you’re 20 years old.
By contrast, if my father’s pension drops by 70% then my whole family is in a lot of trouble. Many pensioners still need to invest for the next 10 to 20 years so their time horizon isn’t zero, but they need to draw down on capital frequently so they must have some liquid short-term focused assets. Plus, they don’t have an income to replenish lost savings, so they are reliant on the current pot of capital. I.E. they must be reasonably conservative with their strategy. Unless they’re super knowledgeable about bitcoin and have vast experience investing in volatile assets, people above the age of 70 are unlikely to make allocations above 5% or 10% of their total portfolio in bitcoin.
Financial situation, goal, time horizon and age all inform your risk tolerance, but over and above this some people have a natural tolerance for risk. Others don’t. Lower risk tolerance does not imply that you should avoid bitcoin, but you should be aware of your natural tendencies and conduct the requisite research before making large allocations. Large bitcoin drawdowns can be stressful. It’s emotionally taxing when you start questioning the very foundations of your decision-making process. So, if you’re risk adverse cover these bases. Higher risk individuals are less likely to dwell on their past decisions and may be better equipped to stomach the volatility.
Most people never manage their own investments and prefer to employ professionals to invest on their behalf. While there are some managers investing into bitcoin, most won’t provide you with exposure due to the lack of regulatory clarity, their lack of understanding of the technology or their decision that it’s not appropriate for your portfolio. If you’re in this position, you need to recognise that making a direct investment into bitcoin is a large responsibility. You have now taken the responsibility to conduct diligence on the asset, understand the regulation, appreciate the tax consequences and decide when to sell. Once again, these are not insurmountable.
If you’ve checked the previous boxes; if you’ve got a long-time horizon, if you’ve got high risk tolerance, if you’re financially secure or if you’re reasonably young then you’ve got plenty of reason to overcome a lack of experience. But are you prepared to push through? Where do you get your information? Do you trust that source? Do you have someone to talk to about this? A network or community where you can voice your questions and get thought-out answers is super valuable! One day in bitcoin you can think you’re a hero and the next you can think you’re an idiot. It helps to have people you can talk to who can tell you that you’re not crazy.
Your understanding of bitcoin, the reasons it exists, the problems with the current financial system and the positive impact bitcoin has on society are MAJOR determinants of position sizing. Many bitcoiners feel that they understand these factors so well that they hold most of their financial wealth in bitcoin. They’re so confident in the technology and ideologically wedded to its potential impact on society that they that it’s rational for them to hold concentrated positions. I fall somewhere in this camp, but I do not recommend this for others. I’m just highlighting the one end of the spectrum.
Everyone is on a spectrum between 0% and 100% allocation. The more you understand bitcoin and the positive impact it could have, the less concerned you become with volatility. Whereas, if you understand nothing about bitcoin at all and you’re purely making an allocation to diversify your portfolio, then you probably want to limit your position-sizing to 10% max, probably closer to 1% or 5%.
Here are a few caricatures to think through your final decision:
Perhaps you’re a conservative person, perhaps you’re older, perhaps your time horizon isn’t longer than 5 years… Well then you probably need to limit allocations to 5%. I’ve shown that a 1% allocation has almost no impact on volatility and made the argument that you should get off zero. I stand by this. If you’re not in financial distress and you have a timeframe longer than 2 years, then you should have at least 1% of your wealth in bitcoin.
Perhaps you’re under 30, perhaps you have more experience with investments, perhaps you’re a risk-loving person or perhaps you don’t need this capital for anything in particular any time soon…Well then you could consider starting your allocation at 5% of total wealth. And the more questions to which you answered “yes”, the closer you can take the allocation to 10%.
Once you’ve made a bitcoin allocation and you’ve started to learn more about the tech, the current financial system and the positive impact on society, you may feel emboldened to take bigger allocations than 10% of your portfolio (given bitcoin’s price appreciation potential it’s also very easy for a 5% allocation to increase above 10% during a bull-market). If your time horizon is less than 3 years, if you’re above 60 years of age or if you have very little tolerance for risk, then a 10%+ allocation probably isn’t for you. If you’re not in this camp, score yourself on these criteria and put that to one side.
Now we’ve got to augment those factors with bitcoin knowledge. I’m not arguing that you need to be a bitcoin core developer or miner in order to have larger allocations. But if your knowledge base is limited, it’s very easy to question the primary reasons you’re invested at exactly the wrong time, which could cause you to sell when the price falls.
How do you assess your knowledge of bitcoin? Here are a few questions to help:
You don’t need to answer all these questions to invest. These questions just allow you to assess your own knowledge. The more confident you are in your answers to these questions the larger your bitcoin allocation may become. At that stage, you may no longer need my help thinking through these questions.
Bitcoin truly is a revolutionary technology and potentially a once in a life-time opportunity. If you know this already, you may be a bitcoin maximalist with greater than 50% of your wealth in bitcoin. That’s obviously a very concentrated position in a volatile asset class. No financial advisor would recommend this because they could probably be sued for making such unconventional advice. But if you’re ideologically wedded to bitcoin, you’re not going to listen to your financial advisor. That decision needs to be made on your own terms because you’re taking a large unconventional risk.
This article provides you with a framework to responsibly match your conditions and your knowledge with your bitcoin allocation. Position sizing is critical to make sure you have a positive experience in a very unusual investment but one with incredible potential.