- There’s no single ‘correct’ way to invest in crypto, brokerage firm Charles Schwab has found in a new research report coinciding with the upcoming launch of its new crypto investing platform.
- The report highlighted two approaches to crypto investing, a returns-based approach and a risk-based approach, with a warning to remain cautious due to crypto’s volatility.
According to US financial services and brokerage giant Charles Schwab, there’s no single “correct” way to invest in cryptocurrencies, with each investor’s approach needing to be tailored to their specific goals, risk tolerance, outlook, and investing timelines.
This insight came in a research report published by the financial services giant Monday. Schwab’s report comes as the firm looks set to launch its first foray into direct crypto investing, Schwab Crypto. Currently, Schwab clients can only gain exposure to crypto through exchange-traded funds (ETFs) and other indirect crypto investments.
In the past, Schwab has been critical of digital assets, in 2019 Rob Farmer, Schwab’s managing director for corporate communications, said that “investors should view these currencies as a purely speculative instrument.”
The ‘Portfolio construction with cryptocurrencies’ report’s author, Jim Ferraioli, director of digital currencies research and strategy at the Schwab Center for Financial Research, laid out two strategies to help individuals make crypto investing decisions:
- A returns-based strategy in which crypto allocations are based on estimates of expected returns and volatility; and
- A risk-based strategy in which crypto allocations are made based on the amount of volatility they add to an investor’s overall portfolio.
“These approaches can be used in conjunction to help investors make informed decisions if they want to incorporate cryptocurrencies in their portfolio,” Ferraioli explained.
Regardless of how an investor makes their crypto investing decisions, Ferraioli cautioned that crypto remains much more volatile than more traditional investments like stocks and bonds.
“Investors who choose to incorporate cryptocurrencies within their portfolios should recognize that they are highly volatile and therefore need careful consideration when weighing allocation decisions relative to traditional exposures,” he said.
Ferraioli added that because of crypto’s high volatility compared to other asset classes, it will tend to have an outsized influence on a portfolio’s overall performance.
“As weightings increase, even modestly, one’s portfolio performance will be increasingly attributable to performance of the cryptocurrency allocation.”
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Schwab’s Crypto Investing Approaches in Detail
According to Ferraioli’s returns-based strategy — also known as a “mean-variance optimisation” approach — the allocation of crypto will increase as estimated expected returns increase. Pretty simple, really. Low expected returns may not justify an investment in crypto at all under this approach, as other assets may be a better option.
The report suggested a conservative Bitcoin allocation of 1%, a moderate allocation of around 6.6% and an aggressive allocation of 8.8% if expected returns are in the range of 15% per year.
This strategy factors in volatility, so a more volatile cryptocurrency would justify smaller allocations for the same level of expected return. For Ether, which is significantly more volatile than Bitcoin, the report suggests a conservative allocation of 0.1%, a moderate allocation of 2% and an aggressive allocation of 2.5%.
Using the risk-based approach, example allocations in the report were made based on the total portfolio risk the crypto investments account for, with a 5% for a conservative allocation, 10% for moderate and 15% for aggressive. In the example portfolios, the crypto exposure was taken out of the equity allocation of the portfolio.
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The report found that just a 1.2% allocation to Bitcoin, or a 0.9% allocation to Ether in a portfolio, could account for 10% of the portfolio’s overall risk.
“Our research suggests that cryptocurrencies can provide some diversification benefits in a portfolio that is already allocated to a mix of traditional investments such as stocks, bonds, and cash,” the report said.
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