David Ramirez, CFA, Co-Founder and Chief Investment Officer of ForUsAll
For an industry that’s been focused for more than a decade on creating set-it-and-forget-it solutions for apathetic 401(k) investors, the idea of offering an asset as volatile and complicated as cryptocurrency in a workplace retirement plan is an anathema.
But if the ultimate goal is to better prepare plan participants for retirement, then cryptocurrency — coupled with expert guidance — is an option to consider. To be sure, not every 401(k) investor needs to allocate a portion of their portfolio to cryptocurrency, but it’s an option that I believe should be available for employees.
Cryptocurrencies are a relatively new asset class with material diversification benefits. When used appropriately, they may increase expected returns without increasing overall expected risk, making them attractive options for investors who adhere to modern portfolio theory.
During my time cofounding a firm that specializes in alternate 401(k) investments like cryptocurrency, I’ve seen firsthand that while some cryptocurrencies have relatively short return histories, leaders like bitcoin and Ethereum have return histories that have exhibited low correlations and a novel risk-return tradeoff relative to traditional asset classes such as stocks, bonds, currencies and commodities.
Cryptocurrency Investor Examples
Those characteristics have already convinced many institutional investors to allocate a portion of their portfolio to cryptocurrency as a means of increasing expected returns without necessarily increasing expected risk. More than a third of global institutional investors already invest in digital assets, according to a recent Fidelity survey, and more than 60% believe that digital assets have a place in portfolios.
In December, MassMutual made a $100 million bitcoin purchase (paywall) for its general investment account, and endowments including Harvard, Yale and Brown have all made allocations. Such increased allocations represent a paradigm shift in the understanding of cryptocurrency and a growing recognition that many cryptocurrencies may provide an intrinsic value — beyond price speculation — that presents a new way for investors to benefit from emerging technologies and Web 3.0.
Take ETH, for example. It’s used for Ethereum blockchain and fuels a dizzying array of new products and technologies, including the Brave’s Basic Attention Token, which compensates internet users for their time and attention online. In April, the European Investment Bank used Ethereum to issue its inaugural digital bond on a public blockchain, and the blockchain has also become a means for decentralized finance to instantly trade via smart contracts. More recently, the country of El Salvador made bitcoin legal tender.
Growing Demand, Lingering Concerns
There’s increasing demand from a variety of investors. Approximately 81% of financial advisors said they received questions from clients about crypto last year. Still, plan sponsors have hesitated to incorporate crypto investment options for several reasons, including concerns about their fiduciary duty and Employee Retirement Income Security Act (ERISA) guidelines. However, ERISA doesn’t restrict any specific asset classes, and there are ways to give 401(k) access to investors without running afoul of fiduciary responsibilities.
Plan participants, for example, should get access to high-quality, personalized educational content and tools to make sure they understand the asset, the risks associated with it and the role it can play in a properly diversified portfolio. Plan advisors should then monitor allocations and alert employees when their crypto allocation exceeds prudent thresholds.
Of course, 401(k) investors — like institutional investors — must approach crypto investments prudently, recognizing that a small allocation may be a sensible portfolio diversifier rather than an opportunity to go all-in with their retirement savings. Despite its benefits, cryptocurrency remains a risky asset, with volatility that’s greater than that of traditional asset classes.
As is the case with new technology, historically, the market can get ahead of itself, and it’s critical that investors keep in mind the potential for significant price fluctuations over time. The appropriate allocation varies, depending on the investor’s age and time horizon. However, looking at allocation in the global market portfolio or optimizing based on historical returns puts a prudent allocation somewhere around 1% to 6% of a portfolio.
Access to an advisor who can answer questions and guide 401(k) investors as they add cryptocurrency to their portfolio is vital. The advisor should also monitor plan participant investments, reaching out to caution those who start to build up an imprudent allocation. Another way for 401(k) investors to get exposure to the asset class is via managed accounts, where a professional can select and monitor an allocation on their behalf.
A Maturing Market
Another common concern among plan sponsors when it comes to cryptocurrency is that it’s too illiquid an investment for 401(k) investors. However, Tesla recently illustrated just how liquid the world’s largest cryptocurrency has become, selling more than $100 million of it in March.
There are other signs that the cryptocurrency market is maturing as well. Coinbase, the cryptocurrency exchange, recently went public and is now worth nearly $86 billion. And there have been significant technological advances in the so-called “cold storage” of cryptocurrency, which allows owners to hold their investment offline (and away from hackers), which has also reduced some concerns around the security of the asset.
As Americans rely more than ever before on their 401(k)s as their best shot at building a nest egg that will support them through retirement, it’s up to plan sponsors to ensure that they have access to the investments that will live up to that responsibility. Given its historical growth trends and growing adoption in broad sectors of the global economy, cryptocurrency is a sector I believe forward-looking plan sponsors can no longer ignore.
The information provided here is not investment or financial advice. You should consult with a licensed professional for advice concerning your specific situation.