A cornerstone of portfolio management is diversification. Modern Portfolio Theory recommends that investors invest in multiple assets, while considering these assets’ expected returns, risk, and correlations. When done prudently, a diversified portfolio can help employees improve expected returns while lowering overall portfolio volatility. Because of their low correlation to traditional assets and relatively high risk-adjusted returns, many institutional and retirement investors are looking to alternative asset classes, such as cryptocurrency, to diversify.
Crypto has a low historic correlation to traditional assets and could be an effective portfolio diversifier.
Researchers at several academic and research institutions have studied cryptocurrency’s place in a modern portfolio. At multiple academic institutions, teams have found evidence to suggest that cryptocurrency can serve as an effective portfolio diversifier. In addition, leading financial institutions, such as FTSE Russell and Morgan Stanley, have also released studies on crypto’s potential advantages in diversified portfolios. Findings suggest that due to cryptocurrency’s low historic correlation with traditional assets, and its high risk-adjusted returns, it can act as a portfolio diversifier. However, despite the mounting evidence to support cryptocurrency’s place in a well-diversified portfolio, everyday Americans have not previously had access to it in their 401(k) accounts, which is one of the most important wealth-building vehicles in the country.
Low correlation to traditional assets
The reason that diversification is crucial to effective portfolio management is that it helps investors to protect their allocations. In short, if one asset experiences a downturn, it can be disastrous for investors who went all-in, especially if these assets tend to behave in tandem. This principle is a key to crypto’s potential as a diversifier.
Research has shown that cryptocurrency has a relatively low correlation to traditional assets. This makes it a strong potential diversifier because it means that cryptocurrency’s market performance is often quite different from the performance of traditional assets, such as stocks. A team at Yale’s National Bureau of Economic Research compared the performance of cryptocurrency to stocks, and found no strong correlation between how the two markets performed. Studies at Western Sydney University and others have found similar results to suggest that crypto has a low historic correlation to traditional assets and could be an effective portfolio diversifier.
High risk-adjusted returns
Put simply, cryptocurrency is a volatile asset. Its volatility means that, while it can experience significant losses, its growth is often significant as well. This is why many economists recommend small allocations to cryptocurrency in a well-diversified portfolio. These small portions of the portfolio can help investors take advantage of periods of high gains, while protecting the bulk of the portfolio from crypto’s downward swings.
Despite cryptocurrency’s volatility, researchers have found that small allocations can increase a portfolio’s expected returns without increasing risk.
Despite cryptocurrency’s volatility, researchers have found that small allocations can increase a portfolio’s expected returns without increasing risk. A research team at FTSE Russell found that increasing the amount of Bitcoin in a model portfolio from 2% to 5% yielded excess gains that rose from 3.2% to 6.4%. However, the risk levels for the model portfolios containing these allocations were not materially increased.
Crypto in a 401(k)
Despite the high institutional interest in crypto, and the growing number of institutional investors who are allocating to it, this potential diversification tool has been left out of 401(k) accounts. If the burgeoning academic and industry research is correct, excluding 401(k) investors from using the same tools leveraged by institutional investors and wealthy families puts them at a structural disadvantage.
The 401(k)'s tax advantages may help everyday Americans save more effectively for retirement, and could make a big difference in their ability to grow their nest eggs.
Though retail investors do have access to cryptocurrency on centralized exchanges, the tax benefits of 401(k) accounts aren’t available there. By using Roth contributions and following applicable guidelines, participants can grow their crypto allocations tax-free*. In contrast, crypto on a centralized exchange can be taxed at up to 37%. Crypto investors who use retail exchanges may also be at risk of having to sell their assets at a loss to cover taxes levied on previous transactions if markets dip later. But with crypto in a 401(k), no taxes are due after the initial Roth deferral, regardless of market performance. These tax advantages may help everyday Americans save more effectively for retirement, and could make a big difference in their ability to grow their nest eggs.
How does it work?
ForUsAll’s new Alt401(k) will be the first 401(k) plan to offer access to cryptocurrency. But, because crypto is risky, our plan design accounts for that. Allocations are capped at 5% of the initial portfolio plus 5% of ongoing contributions. In addition, all participants are given guidance on cryptocurrency’s risks, plus full disclosures regarding fees and participant responsibility. Finally, investors must pass an interactive quiz to demonstrate their understanding of crypto investments before being able to access the self-directed cryptocurrency window. We at ForUsAll believe that everyone deserves access to the same financial tools, but with appropriate guardrails, guidance, and education to help ensure this access is safe.
Talk to one of our representatives if you’re interested in adding a modern 401(k) with prudent cryptocurrency access to your company’s benefits package.
President Biden stated in his recent executive order that, “the United States also has an interest in ensuring that the benefits of financial innovation are enjoyed equitably by all Americans and that any disparate impacts of financial innovation are mitigated.” In order to live up to this goal, everyday Americans must be given access to the assets that professionals have already been using. Talk to one of our representatives if you’re interested in adding a modern 401(k) with prudent cryptocurrency access to your company’s benefits package.
* To be fully tax exempt and subject to withdrawal without penalty, you must meet the 5 year rule for the initial Roth deferral and you must be at least 59 1/2 years old. ForUsAll does not provide tax advice, and the tax laws could change in the future. Consult your retirement plan provider or your accountant for details.