Bitcoin in Your Portfolio: The Risk and Reward of a 5% Allocation

Bitcoin has become increasingly mainstream as a legitimate asset class in portfolios, thanks to the launch of spot Bitcoin ETFs.

Funds such as iShares Bitcoin Trust (NASDAQ: IBIT) and Fidelity Wise Origin Bitcoin Fund allow investors to gain exposure without opening separate crypto wallets.

The total assets managed by these spot Bitcoin ETFs now reach around $100 billion, a significant increase from earlier years.

With the growth of cryptocurrency as an asset class, it's essential to determine how much of a portfolio should be allocated to it and what impact this would have on risk and return.

A 5% allocation is often cited as a good starting point for investors, but the numbers suggest that the decision may not be so straightforward.

Bitcoin is more volatile than the S&P 500 (SNPINDEX: ^GSPC), which means that any money pulled away from stocks would increase portfolio volatility.

However, not all volatility increases risk. The iShares Bitcoin ETF has been roughly 2.5 times more volatile than the Vanguard S&P 500 ETF (NYSEMKT: VOO) but has a low correlation of only 0.4 with the S&P 500.

A historical analysis shows that adding 5% of the portfolio to Bitcoin would have contributed around 7.35% of the overall risk, indicating that the lower correlation could mitigate some of the added risk.