Bitcoin for Diversification- What Are the Risks and Returns?

It’s no secret that many people invest in Bitcoin for diversification purposes. But this digital currency has many return and risk characteristics. So, before adding Bitcoin to your investment portfolio for diversification purposes, consider the risks and returns.

So far, Bitcoin constitutes up to 5% of some investors’ portfolios. Some experts advise investors to include between 1 and 2% of net worth in cryptocurrency investments. However, some experts recommend investing in Bitcoin or any virtual currency only if it provides diversification benefits or performs better, like the different asset classes.

Bitcoin Investment Risk and Return
When analyzing Bitcoin investment risk, consider two inherent and relevant dangers. These are the intrinsic Bitcoin’s return risk per se and the measurement error risk when estimating the risks.

Tautologically, consider the historical data. Past risk and performance are undoubtedly informative. However, the future risk and performance of this virtual currency can differ. And this is mainly a concern when investing in Bitcoin because it has experienced significant volatility invariance and level of daily returns. Thus, this model risk is essential.

Bitcoin’s value or price tends to oscillate wildly. For instance, the value of this virtual currency swung between $50,000 and 63,000. Bitcoin’s annual standard deviation in terms of daily returns is 67%. Thus, the average Bitcoin investment return can fluctuate significantly within a short period. Also, this indicates significant volatility of the average performance of this virtual currency.

Nevertheless, Bitcoin has gained a higher return on average for a significant period in the market. And this explains why more people continue to purchase this virtual currency on platforms like Immediate Edge. Ideally, such platforms enable people to buy Bitcoin using fiat money. After purchasing this virtual currency, you can hold onto it, waiting for its value to appreciate, and then sell your tokens for profits.

Bitcoin for Diversification
As hinted, diversification is another reason for investing in Bitcoin. Diversification allows an investor to realize a higher return per risk unit. Ideally, every asset has two primary risks. And these are idiosyncratic risk and systematic risk.
Idiosyncratic risk is the random movements inherent to the characteristics of an asset. For instance, the risk of an unexpected factory burn is an example of this kind of risk. The CEO can also have a sudden heart attack.

Systematic risk is about the correlation of the asset with market-wide factors. For instance, changes in interest rates can affect the entire market. Systematic risk is ideally about the sensitivity of an investment to the impact of market factors. Investors measure this risk by the asset’s beta concerning the market index. Beta reflects the responsiveness and sensitivity of an asset’s returns to the market index returns.

Bitcoin’s diversification benefits seem tangible but quantifying them is not easy. That’s because Bitcoin’s returns are highly volatile, thereby creating a model risk. A forward-looking Bitcoin returns estimate or risk can likely be incorrect. And both fluctuate significantly over time. Past Bitcoin returns and asset allocations might not necessarily represent future allocations and returns.

Implications of Bitcoin Risks in a Diversified Portfolio
Bitcoin can have diversification benefits. However, these benefits extent can vary over time. What’s more, if a person believes that the expected return will be negative, they may end up being minimal.

Thus, an investor should estimate the expected Bitcoin return, risk, and correlation with a market index. Also, they should determine the correct Bitcoin amount to add to their portfolio for diversification purposes to achieve positive returns. And this amount can change over time. Therefore, an investor should monitor the market and asset allocation continually.