Digital (crypto) assets offer investors a rare opportunity: the ability to invest in an entirely new asset class that is still in its relative infancy. With interest at an all-time high, particularly as younger crypto-savvy investors come of age, financial advisors are facing significant pressure from their clients to provide exposure to this new asset class. Advisors who are able to offer clients this exposure are well positioned to grow their client base and AUM as the asset class matures.
Exposure to digital assets through retirement accounts offers some interesting opportunities for investors to diversify their risk and maximize growth over the course of their investing lifetime. In this article we look into why investing in crypto makes sense generally, as well as some unique benefits when applied to retirement accounts.
Why Invest in Digital Assets?
As digital assets have seen more mainstream interest and support, their value has grown. Every new merchant that accepts payment with cryptocurrency, every new exchange that supports digital asset trading, and every new financial services firm that offers them improves the long-term viability and popularity of this new asset class.
As digital assets experience mainstream adoption, demand increases. And because many cryptocurrencies such as Bitcoin have a fixed supply, increased demand tends to increase their value. Even today, digital assets are still in a relatively early phase of their lifecycle, so these trends will benefit investors who opt in today.
The performance potential of digital assets is well illustrated by the standout performance of Bitcoin over the last 5 years (2016 through 2021) compared with conventional stocks as illustrated below. Bitcoin yielded the best returns when compared with comparables like AMD and Facebook, the S&P, and Gold, appreciating almost two orders of magnitude during the period.
Many investors believe that investing in a mix of stocks and bonds gives their portfolios sufficient diversification to reduce risk. However, that isn’t necessarily correct. Investors need a wide range of assets, across multiple asset classes, to achieve a truly diversified portfolio.
Gold and silver are the traditional investments of choice when diversifying an investment portfolio to protect against macroeconomic uncertainty. Now digital assets are increasingly becoming the new “digital gold and silver”, offering yet another way of protecting investments against market risks. This has become particularly important in the light of inflationary pressures from the fast growth in money supply versus economic output during the COVID pandemic.
One of the main attractions of digital assets in a diversification strategy is their lack of correlation with traditional asset classes. Bitcoin, for example, has maintained low correlations with both the S&P and gold over the last six years.
The Next Wave of Technology
Digital assets and blockchain technology are right at the forefront of growth in almost all industries. The current stage of the blockchain-based business and investing ecosystem has strong parallels with the internet boom in the late 1990s and early 2000s which minted many millionaires and billionaires. As such, digital assets are well positioned to be very much part of future technological advancements and wealth creation. Their importance for investors will continue to grow.
Benefits Specific to Retirement Accounts
Retirement accounts hold perhaps the majority of available investable resources for most middle class investors. As such, they represent a significant percentage of AUM for most financial advisors. Being able to offer exposure to crypto in these accounts is one of the primary ways that advisors can help their clients enjoy the many benefits of digital assets referenced above.
Maximize the Benefits of Active Management
Because retirement accounts are tax deferred, advisors can take advantage of short term market changes by rebalancing and reallocating the portfolio asset mix without resulting in a taxable event. With regular investment accounts, advisors may have their hands tied to annual rebalancing and/or reallocation to maintain long term capital gain tax status. Because this is not the case with retirement accounts, advisors can manage portfolios more actively, buying on dips and selling on highs as they occur without creating taxable events. Over time the effects of such actively managed strategies can become significant.
Balancing Lifetime Performance & Risk
Because retirement accounts mandate keeping funds invested until retirement (typically decades), it makes sense to account for the possibility that monetary policy may disrupt or even destroy the current economic order and pave the way for a new one, similar to what happened with the Internet in the early part of this century. Digital assets offer a unique opportunity to diversify into an asset class that isn’t correlated with the stock market or the US Dollar, that also represents the next stage of the internet, or Web 3.0. That means you can balance your performance and risk over a lifetime of investing.
The Optimal Crypto Allocation
The optimal mix and allocation of digital assets in a retirement portfolio depends on both investment strategy and risk tolerance. Typically, most advisors and asset managers suggest an allocation between 1% and 5%, providing a strong foundation for improved returns with minimal risk. More aggressive investors may find a larger allocation to digital assets appealing.
Digital assets represent a great opportunity for investors to diversify risk and maximize growth in their portfolios, substantial portions of which are locked in retirement accounts. Investment advisors who are able to guide their clients through the process of investing in crypto in these accounts have a great opportunity to grow their client base and AUM in the future, especially as younger more crypto-savvy investors come of age. Understanding the different options and products to provide this exposure for clients is an important next step for advisors.
Disclaimer: The views expressed in this article are solely opinions of the author and do not represent financial or legal advice whether to buy, sell or hold shares of a particular cryptocurrency, cryptographic asset, stock or other investment vehicle. Prior to trading, investing or purchasing any assets, individuals should consult with their own tax, financial or legal advisor. Past performance is no guarantee of future price appreciation.