For financial advisors, client questions about holding cryptocurrency exchange-traded funds in retirement accounts may be on the horizon — if they haven’t started yet.
The October debut of the ProShares Bitcoin Strategy ETF (ticker: BITO) opened new doors for investors. While other crypto-related exchange-traded funds have been on the market for a few years, the ProShares fund is the first cryptocurrency ETF the Securities and Exchange Commission approved for trading.
The ETF holds Bitcoin futures and contracts, not the actual digital currency itself. It grew rapidly and now holds more than $1 billion in assets under management. Its average daily trading volume is 5.2 million shares. That’s not bad for a fund that’s about a month old.
With so much attention to crypto assets, it’s inevitable that financial advisors’ clients might ask about holding crypto in their qualified accounts, such as Roth and traditional individual retirement accounts.
While it can be fun and interesting to own the flavor-of-the-month asset class, investors must also understand the risks. That’s true with any asset, but it’s particularly true if investors are reading about crypto in their social media feeds and seeing ads for crypto platforms on their phones.
[ SUBSCRIBE: Get the weekly U.S. News newsletter for financial advisors. ]
A Volatile Asset Class
Crypto differs from traditional equity and fixed-income assets in that prices can quickly become volatile, and investments may soar or crash in a short period of time. That’s certainly the reality for stocks, but in the crypto world, the pace of price movements can be much faster and steeper.
Nonetheless, the same investing rules apply: Understand that cryptocurrencies, even when accessed through an ETF, have a high risk profile. That’s also true of other investments, such as emerging market stocks.
So how should investors handle crypto assets in a retirement account? Much of the advice circulating is focused on trading, not on long-term investing or assessing how a crypto ETF fits into an allocated portfolio.
Although retirement accounts eventually provide income, savers don’t necessarily have to put their money solely into income-producing assets, says Ric Edelman, longtime owner of an eponymous registered investment advisory firm, which merged with Financial Engines in 2018, who now serves as founder of the Digital Asset Council of Financial Professionals based in Fairfax, Virginia.
“Instead, it’s entirely reasonable to invest a portion — perhaps the majority of your account — into growth-oriented investments,” he says. “The ideal portfolio mix consists of a combination of stocks and bonds, and to that end, the inclusion of digital assets makes perfect sense.”
Edelman adds that since its inception in 2009, Bitcoin has proven to be an excellent way to improve portfolio diversification.
“Although past performance does not guarantee future results, history shows that adding a small allocation to Bitcoin — even as little as 1% of your account — has improved returns while reducing risk,” he says.
Because retirement accounts don’t pay taxes on profits annually, the growth gets to compound faster, Edelman says. He says this makes digital assets an ideal choice for inclusion in retirement accounts.
Given that there’s no historical performance record for the ProShares ETF, or for other new crypto-related ETFs, it may be wise to limit the exposure to crypto within a qualified account.
“I’d recommend keeping the allocation to 1%,” Edelman says. “If Bitcoin performs in the future as well as many expect, this is sufficient to materially improve your overall portfolio returns.”
However, he adds that as an emerging asset class with many risks, crypto could still notch poor returns. In that case, losing 1% of the portfolio won’t destroy an investor’s ability to achieve financial security in retirement, he adds.
Risk of Futures Contracts
Futures contracts are inherently risky investments, says Martin Smith, president of Wealthcare Financial Group in Peachtree City, Georgia.
“However, unlike an aggressive growth mutual fund that may fall in the high-risk category, there is a learning curve involved with trading futures contracts that is not common with mutual funds,” he says.
Smith does not advise his clients to purchase a futures contract of any sort within an IRA, as it amounts to a form of speculating.
“Assuming that there may be other investments in the IRA, if margin is involved with the purchase of a futures contract, investors could inadvertently expose their IRA to some of the risks that are unique to futures contracts, such as the negative impact of an expiring contract on the underlying investment,” he says.
For clients who want to allocate a small portion of their portfolio to crypto, Smith recommends limiting exposure.
“If a client wants to allocate a small portion of their portfolio in an investment that is speculative, such as the new Bitcoin futures contract, I want them to have a plan for how much they’re going to commit to that investment and not exceed that amount,” he says.
He points out that for some investors, it’s tempting to double down on an underperforming investment, believing that it will recover and eventually break even. Smith says other investors may be tempted to add to their position as its value increases.
“In either scenario, the investor may run the risk of throwing good money after bad, or raising one’s cost basis by chasing an appreciating asset,” Smith says.
In those situations, an investor may misunderstand what the actual value of the security should be.
“I advise having a plan, sticking to it and not allowing one’s emotions to get them off course,” Smith says.
More from U.S. News
Advisors, Do Crypto ETFs Belong in Qualified Retirement Accounts? originally appeared on usnews.com