How Much Bitcoin Are You Willing to Lose?

Question: What do you call an asset that appreciates 5,555,456% in a little over 7 years?

Answer: Bitcoin.

In 2010, when Bitcoin was trading at $.09 that word meant nothing to most investors. Earlier this month when it crossed above $5,000, it was all investors wanted to talk about.


What changed? The price. It went up, and up, and up.

The thought of turning $10,000 into over $555 million is, needless to say, enticing to some.


As is the thought of owning something that seems to hit a new all-time high milestone nearly every single day.


At a certain point, the fear of missing out (FOMO) becomes palpable: many simply can’t stand seeing Bitcoin go up any longer.

How do I know this is true? In late August, investors in the “Bitcoin Investment Trust” were paying $1,005 for Bitcoin assets worth $432, an incredible 132% premium to NAV. Why would a rational investor pay such a hefty premium? Simple: they think they will sell it to someone else at an even higher price. And besides, who said investors were rational?


Leaving aside whether FOMO is good reason to invest in something, what was the risk tolerance of an investor buying into Bitcoin at $5,000? In plain English: how much Bitcoin were they willing and able lose?

A simple question with a not-so-simple answer, especially after an asset class has gone parabolic. We tend to become blinded by such astronomical gains, failing to remember the risk part of the risk/return equation.

I know, I know, Bitcoin never seems goes down. It is the currency of the future. Why worry about risk in an asset that only goes in one direction?

Just humor me for a minute, and try to imagine a world in which Bitcoin drops 39%, 85%, or 94%.

Sounds crazy, I know. But you’ll notice in the table below that this is not a theoretical exercise. In 2011, it went from $32 to $2 in the span of 5 months, declining 94%. From late 2013 to early 2015, it went from 1,166 to $170, an 85% decline. And as recently as June to July of this year, it dropped 39% ($3,025 to $1,837).


In the past two weeks, Bitcoin has sold off 25% from its all-time high. Is that the end of the correction or the start of something much bigger?

I have no idea; nobody does. What I do know is that such a decline is far from atypical and investors in Bitcoin need to understand the risk they are taking.

Lost in the mania this year is the most critical question when it comes to portfolio returns: how much of an allocation are you going to give to each asset class. How much weight will you give to Bitcoin?

Even at its peak market cap of just over $80 billion, Bitcoin would represent less than a .02% allocation to a global market portfolio (click here for my post on this). Needless to say, such a small allocation today would have to have to experience unfathomable returns to make a dent in you overall portfolio returns. For instance, if Bitcoin went from $5,000 to $500,000 (a 10,000% return), it would contribute only 2% to overall returns.

Let’s say you don’t subscribe to traditional market-cap based weightings, and want to take a larger position of 5%, 10%, or more. You believe in Bitcoin and want its impact to be meaningful. That’s your prerogative, just be sure to know what you own, why you own it, and how long you plan on holding it for.

This is an asset with 72% annualized volatility over the past year and historical drawdowns that make the equity market look tame by comparison. Could you handle a 50-90% decline? Would you stick with it for years without making new highs? Can you sleep at night knowing that your account could be hacked into at any moment, losing all of your holdings?

If your answer to all of these questions is yes, how do you size such a position and how will you determine when to adjust that size?

These are just a few of the questions you need to be asking yourself – in advance – to have any chance in sticking with Bitcoin over time. I would spend less time predicting where Bitcoin is going (an impossible task) and more time figuring out how (if at all) it fits into your overall asset allocation plan.




Related Posts:

The Evolution of Money

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This writing is for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction, or as an offer to provide advisory or other services by Pension Partners, LLC in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Pension Partners, LLC expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.



Charlie Bilello is the Director of Research at Pension Partners, LLC, an investment advisor that manages mutual funds and separate accounts. He is the co-author of four award-winning research papers on market anomalies and investing. Mr. Bilello is responsible for strategy development, investment research and communicating the firm’s investment themes and portfolio positioning to clients. Prior to joining Pension Partners, he was the Managing Member of Momentum Global Advisors and previously held positions as a Credit, Equity and Hedge Fund Analyst at billion dollar alternative investment firms.

Mr. Bilello holds a J.D. and M.B.A. in Finance and Accounting from Fordham University and a B.A. in Economics from Binghamton University. He is a Chartered Market Technician (CMT) and a Member of the Market Technicians Association. Mr. Bilello also holds the Certified Public Accountant (CPA) certificate.

You can follow Charlie on twitter here.

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