kayanco wrote: ↑
Thu Sep 07, 2017 12:36 pm
Over time I've come to respect and value your collective knowledge and willingness to discuss and help each other understand stuff.
Based on my poor (and likely flawed) understanding of the actual reasons behind the 3-fund portfolio or index investing in general, I want to discuss if Bitcoin can/should be included in a broad indexed portfolio.
Points of discussion:
I believe one of the reasons for including bonds and international is that they are supposed to have low correlation with each other (at least in theory). I've read that Bitcoin has low correlation with stocks and bonds. So would this be a reason to include Bitcoin in a portfolio?
(To be clear, I'm not asserting that Bitcoin has a low correlation. It's just something I came across. My question in other words is, assuming that it has a low correlation, would it then be a good idea to include it?
Another feature/benefit of a total market index that I've read about, is that is gives you some exposure to a future blockbuster company. Let's say there's a low priced company today that goes big in the future. Holding an index would ensure some share of that. And the reverse. If a single company goes bust, the loss would be limited.
So does this line of reasoning imply holding bitcoin? If it becomes even bigger (as speculated), holding some % of it in a portfolio would give some portion of that bounty. But if it turns out to be a digital Tulip, the loss wouldn't be catastrophic.
Nassim Taleb's barbell concept.
Where I believe he recommends some 90% investment in sometime safe, and 10% risky.
Can Bitcoin/crypot-currency be in that 10%? That is, 90% of portfolio = 3-fund portfolio, and 10% = Crypto-currency (or any other risky combination, e.g. 5% Crypto, 5% Biotech, etc, etc.). Would this be an implementation of his barbell concept? If not, please explain why.
Please share your thoughts/critique.
My aim is not to say that this is a good idea. If it's a bad idea, I'd like to understand why.
In my opinion, using bitcoin in a 3-fund indexed portfolio is a terrible idea. First of all, there is absolutely no evidence to suggest that bitcoin is in fact uncorrelated or has a low correlation with stocks. To use it as the uncorrelated stock asset as in your portfolio is like building the foundation of your house on a bed of sticks you've never seen before.
The boglehead portfolio is not a get rich quick scheme. The assumptions we make and the principles we employ as the fundamental edifices of the paradigm must endure for decades.
In the case of diversified stocks and bonds it just so happens we actually have decades of evidence.
For example, in order for the boglehead portfolio to function properly, a certain kind of relationship has to hold. One implicit assumption we bogleheads make is that bonds will not in the future all of a sudden become 100% correlated to stocks. Nobody talks about this possibility, but it is clear that in order for a 3 fund portfolio to act like a three fund portfolio, the three funds cannot act identically.
Bitcoin has two major factors which make it a poor choice. First of all, bitcoin does not produce anything of value. If you're using it as a growth asset in your portfolio, know that it's value is driven purely by what someone else will pay for it. Think about what that means. If you incorporate that into your portfolio, you're basing the long term value of portfolio rebalancing on people out-speculating each other.
Secondly, to the extent you're using bitcoin as an uncorrelated liquid asset, it is inferior to bonds and cash. Why?
The purpose of the bond portion of your portfolio is to produce something better than cash. Stocks drive the growth. Bonds are for the safety. The point of this is to rebalance the risky portion of your portfolio against something that is either uncorrelated, lower risk, or hopefully both. In other words, when you sell the stock portion of your allocation, you're not using those proceeds to buy pink sheets or tulip bulbs. That would undermine the purpose of the exercise. The growth of the three fund portfolio depends on the stability of what you're rebalancing into when you sell stocks, so that when you choose to rebalance back into your risky asset you can be assured your money will be there.
There's no point in rebalancing out of stocks into bonds, if when you sell your bonds to go back into your stocks, the bond portion has dropped 10%/20% etc. Bitcoin's volatility at this point far exceeds the stock market. That alone makes it completely unsuitable for the bond portion of your 3 fund portfolio.
A bad investment strategy doesn't necessarily mean one will lose money. I can let it all ride on black and still make a killing. I'm not saying bitcoin will lose money. What I am saying however is that none of bitcoin's characteristics thus far make it unsuitable for any portion of a three fund portfolio. At best it is a complete unknown. And at worse, empirical evidence suggests that it functions in a manner that completely contravenes sound investment principles for the long term.