Why you shouldn't add Bitcoin to your retirement portfolio

The steady path to a dream retirement
The steady path to a dream retirement

I have a portfolio invested mainly in stocks and bonds, but I’m not pleased with the returns it’s earning. So I’m thinking about expanding into other kinds of investments. Do you think this is a good idea? And do you have any suggestions for what I should add to boost my returns? –A.N.

I’m sure you’ll have no trouble finding financial advisers who will encourage you to dramatically broaden your investing palette in the name of diversification, higher returns or both.

I’m also confident those advisers will have no trouble coming up with a long list of alternative investments for you to consider, ranging from the usual suspects like commodities, precious metals, hedge funds, private equity and absolute-return funds to more arcane vehicles like equipment leases, tax lien certificates, structured settlements and fishing rights, to name a few.

Some might even suggest taking a flier on Bitcoin, the wonder investment whose price has soared from less than $ 1,000 at the beginning of the year to almost $ 20,000 recently (although, who knows, it could have risen or fallen by several thousand dollars in the time it took to read this sentence).

But I’m not part of the “more is better” chorus. I’m a “less is more and simpler is better” kind of guy. In fact, I’d go so far as to say that once you start expanding your investment horizon beyond a broadly diversified portfolio of stocks and bonds (or stock and bond funds or ETFs), you also run the risk of ending up with jumble of investments that are costly and difficult to manage. In short, you may wind up “di-worse-ifying” rather than diversifying.

That’s not to say that adding a few well-placed alt investments may not be able to better diversify a portfolio while simultaneously boosting its return potential (although, at this point, I wouldn’t put any serious money into Bitcoin, given the difficulty of estimating its fundamental value).

Related: How should I invest my retirement savings for safety and income?

But if you hope to improve your portfolio’s return without simply ratcheting up risk, you can’t just throw more investments into your portfolio willy-nilly. You’ve got to consider each investment’s expected return, figure out how your various investments will interact with one another and determine what percentage of your portfolio’s assets each of your investments should represent.

Even for investment pros using sophisticated software, this is no simple task, nor is there any guarantee that the results will come in as projected. I think it’s fair to say that most individual investors would have trouble doing all this in a systematic and disciplined way on their own.

Of course, there’s no shortage of advisers who will claim that they can skillfully integrate any number of alt investments into your portfolio and manage it so your portfolio performs like a charm. And maybe after doing some research on their track records, you’ll be able to identify ones who can actually do so (or at least have managed it in the past). But you’ll have to pay them a yearly fee to create and monitor your various holdings. Add that charge to the underlying costs of the investments themselves — which in many cases can be quite hefty in the case of alt investments — and the overall costs can seriously erode any potential benefit.

Given the difficulty and the cost of putting together a complicated portfolio and the possibility that it may not perform as well as you hope, I think the vast majority of investors — by which I mean people who aren’t investing tens of millions of dollars or more — are probably better off just sticking to a broadly diversified portfolio of stock and bond funds or ETFs.

Which brings us back to your situation. You say you have a portfolio of stocks and bonds, but you aren’t pleased with the returns you’re earning. I find that puzzling. In the nearly nine years since the market hit bottom in the financial crisis, stocks have been going gangbusters. In fact, returns have been so strong — nearly an annualized 20% since March, 2009 — that many investment pros are wondering how much longer this bull market can last. And while bonds haven’t kept us with stocks’ torrid pace, their performance over that time has been respectable, just under 4% a year.

So if you’ve had anything close to a decent dollop of stocks in your portfolio, I would think you should have enjoyed some pretty decent gains. That makes me wonder whether the reason you’re not pleased with your portfolio’s performance is that you have unrealistic expectations. If that’s the case, you need to re-set them.

Fact is, many investment pros believe returns over the next decade or so will be several percentage points lower than they’ve been in the past. That’s not to say you can’t search for investments that will buck the trend. But the potential for higher returns always comes with higher risk. And even if you’re okay taking on that heightened risk, there’s no guarantee the loftier returns will materialize.

If, on the other hand, the problem isn’t with your return expectations and the returns you’re earning are actually subpar, then maybe there’s something about your portfolio or the way it’s being managed that accounts for its anemic performance. Perhaps it’s not properly diversified or you’re paying too much in costs and fees, or maybe you’ve lost out on returns by moving your money in and out of the market at inopportune times.

If that’s the case, then I’d say the right way to address your dissatisfaction isn’t to launch a search for alternative investments, but to re-assess your holdings with the aim of creating a portfolio of stocks and bonds that can actually give you a better shot at reaping whatever gains the market delivers.

Start by determining whether your portfolio is truly diversified. Basically, you want to make sure you have exposure to virtually all sectors of the stock and bond markets. That would mean owning large-, mid- and small-cap stocks as well as growth and value shares and a broad swath of investment-grade bonds, both government and corporate issues.

For even broader diversification, you can also add foreign stocks and bonds, including those of developed and emerging markets. You could build such a broadly diversified portfolio on your own, but it would be much easier to simply invest in a total U.S. stock market stock index fund and total U.S. bond market index fund for domestic exposure and a total international stock index and total international bond index fund for exposure to the rest of the world.

Related: Do you need a managed retirement account?

Next, you’ll want to make sure your portfolio reflects your tolerance for risk. Generally, the more you invest in stocks, the greater your portfolio’s return potential. But you also want to have enough of your money in bonds so that when the market goes into one of its periodic meltdowns, you’ll be able to weather the setback without panicking and selling your stocks when prices are depressed. There’s no stocks-bonds mix that’s ideal for everyone, but you can get a good idea of what blend may be right for you by completing Vanguard’s free risk tolerance-asset allocation questionnaire.

Finally, hold the line on investment fees. I can’t say that every dollar you save in costs translates exactly into an extra dollar of return, but Morningstar research shows that fees are the best predictor of fund performance and that funds with low annual charges tend to deliver higher returns than those with more onerous levies. You can search for funds with low fees by going to Morningstar’s Fund or ETF screener. Or you can simply stick as much as possible to broad low-cost index funds or ETFs, many of which have annual expenses of less than 0.20%, or well below half the amount many actively managed funds charge.

If after going through the assessment I’ve outlived above you still feel the need to expand into alternative assets, then at least hold the amount you invest to a small percentage of your overall holdings and try to keep costs down. Otherwise, you may end up writing me again, only next time to ask how to go about restoring order to an unwieldy portfolio that’s difficult to manage and expensive to boot.

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