The profitability of Bitcoin as an investment option is much debated. Market analysts are divided as to whether the asset is a good investment to add to a portfolio. Others have merely indicated that the asset offers investors an opportunity to diversify into riskier assets. Boosting an already conservative investment portfolio.
The latter mindset was featured in a recent report by The Economist on the opportunity presented by an extremely volatile asset like Bitcoin. In his report, the author dissects Harry Markowitz’s 1952 Nobel Prize in the Journal of Finance. Markowitz, then a young economist who was considered a genius, postulated what is now known as the “modern portfolio theory”.
Related reading | Ex-Goldman Sachs breaks down why Bitcoin and crypto will prevail over the SEC
The paper reduced a compound investment portfolio to one that contains both risk-free and highly volatile assets. That way, if one asset failed, the others would be left to make up for the loss of the former. The integrity of the returns in the portfolio is preserved. Additionally, Markowitz contended that the risk associated with an asset like Bitcoin may not be the most important. But rather the volatility that such a risky asset adds makes it an important addition.
Removing volatility entirely from a portfolio will undoubtedly result in lower returns. This is mainly because the less risky an asset, the lower the return on that asset. Take an investment such as bonds as an example. Bond yields typically have an annual return of 1-5%, sometimes even lower because bonds are relatively safe assets. For investors looking for a higher return on their investments, volatile assets are a must. This is where assets like Bitcoin come into play.
Bitcoin returns speak for themselves
Although Bitcoin’s returns are very volatile, they have proven to be worth the risk of the asset. Bitcoin fully embodies the theory advocated by Markowitz in his paper. An important addition to a portfolio with high and reliable returns. Its returns also play an important role in the inclusion of the asset in any portfolio. Despite seemingly regular dips and rises, the investment’s returns have outperformed almost all investment mechanisms known today.
Related reading | Data shows that Bitcoin trading is napping during Asian market hours
The theory assumes that a portfolio has an, albeit small, percentage of volatile assets. The Economist points to the investment strategy of hedge fund manager Paul Tudor Jones, which he revealed earlier this year. Jones stated that he held about 5% of his entire portfolio in Bitcoin. Since Jones is a seasoned investor, it cannot be said for long that the portfolio is highly diversified. And, in its diversity, includes such a volatile asset as Bitcoin.
BTC rises to over $ 44,000 | Source: BTCUSD on TradingView.com
The report adds that any balanced portfolio currently requires a bitcoin position of around 1-5% of the total value. Not only because of the high returns on the asset, but also that portfolios that even had a 1% position in Bitcoin exhibited better risk-return characteristics compared to portfolios without Bitcoin investments.
In conclusion, the report notes that it remains unclear what is the driving force behind Bitcoin’s returns. And investors have yet to decide whether the asset is “salvation or damnation.” “However, neither side is likely to hold 1% of its assets in it,” the report said.
Featured image from Skalex, diagram from TradingView.com