Looking to add crypto to your retirement portfolio? Here you can find out how and what to watch out for.

With many cryptocurrencies skyrocketing over the past year as the total market surpassed $3 trillion, a growing number of retirees are looking for ways to capitalize on the potential. Before joining the crowd, however, investors should at least acquire a basic understanding of the asset class, unless they become experts in the esoteric investing themselves.

For starters, investors will likely be on their own for adding cryptocurrencies to their investment mix, as traditional individual retirement accounts and company-sponsored 401(k) plans typically don’t allow for investments in crypto or other alternative assets. That leaves investors to deal with digital currencies in self-directed IRAs or in taxable accounts.

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Additionally, crypto’s unexpected rewards come with risks that can make it difficult for professional investors to stay in the green, let alone large investors. Digital currencies have been the best-performing asset class in the world over the past three years, but have also had multiple drawdowns of more than 50% during that time.

“The market is new and changing rapidly,” said Matt Hougan, Chief Investment Officer at Bitwise Asset Management. “Crypto investments can go to zero and there is no guarantee that today’s largest and most important assets will remain so in the future.”

Barron’s spoke to a number of investment professionals about some things to consider:

Is it advisable to bet on crypto?

A key argument for adding crypto to retirement savings is the diversification benefit of an asset class that is largely uncorrelated to traditional assets. Crypto is also being touted by enthusiasts as an emerging asset class that maximizes returns relative to the risk investors take. And by investing in a qualifying retirement account, all gains are tax-exempt or tax-free, depending on the account type.

David Ramirez, chief investment officer at 401(k) provider ForUsAll, believes investors have more to lose by not adding digital assets to their retirement plans. “Deciding not to include cryptocurrency in a diversified long-term portfolio is a big bet,” he says. It is “a gamble that markets are inefficient and that large institutional investors fundamentally misunderstand the potential of blockchain technology.”

A small allocation to cryptocurrency in a diversified portfolio can potentially boost expected returns without significantly increasing the portfolio’s overall risk, he says. In fact, a FTSE-Russell simulation last year found that cryptocurrency portfolios consistently outperformed non-cryptocurrency portfolios without significantly increasing risk.

How can I build crypto into my retirement plan?

The easiest way to buy crypto in a retirement account is through tax-free, self-directed IRAs and Solo 401(k) plans. Investors can choose from companies like Bitcoin IRA, BitIRA, iTrust Capital, and IRA Financial, among others, that specialize in crypto-backed IRAs; Big financial companies like Fidelity and Vanguard do not allow individual investors to invest in crypto. Once your account is funded, you can trade digital assets in your self-directed retirement account using the platform’s self-trading section.

Then there are custodians like IRA Financial, which allow clients to invest in digital currencies directly through a crypto exchange. Investors can use their retirement savings to buy all major cryptocurrencies directly through a US-based exchange. The IRA holder has 100% control of the account and can trade at any time.

Until recently, crypto investing was taboo for company-sponsored 401(k) plans. That changed in July 2021, when ForUsAll partnered with Coinbase Global to allow workers on Coinbase Global-managed plans to invest up to 5% of their 401(k) posts in Bitcoin, Ethereum, Litecoin, and other coins.

While outright ownership can be an efficient way to get exposure, Hougan warns, “it takes a lot of monitoring, management and attention to managing those positions over time.” For some, professionally managed cryptocurrency ETFs might be a better way to get exposure be crypto market, he says.

How much should I allocate?

Key factors that determine the size of crypto allocation include “age, wealth, and appetite for risk and volatility,” says Adam Bergman, founder and CEO of IRA Financial Group, which holds about 5% of its assets in crypto . However, he admits, “that can be a bit high for some individuals.”

Considering the volatile nature of crypto, a little goes a long way. “Most of the investors we work with have between 1% and 5% of their retirement portfolio in crypto,” says Hougan.

With the allocation comes a regular rebalancing. Crypto allocation must be routinely adjusted to align with investment objectives. “Because there can be such outsized returns up and down, rebalancing in crypto can be even more important than other assets,” says Hougan.

And which coins should I choose?

Crypto experts tend to favor blue-chip coins — for example, established core cryptocurrencies like Bitcoin and Ethereum — over upstart ones.

Coin selection correlates with investor risk appetite. Bitcoin and Ethereum are the two largest cryptos and probably the least risky. However, you are not immune to price fluctuations. Bitcoin has surged from a peak of $65,000 to $31,000 in late 2021 and early 2022 in just a few months; it recently traded around $45,000.

Volatility could be significantly higher in smaller, less established cryptocurrencies. However, some of the best-performing assets in 2021 have been altcoins like Solana, which is up more than 9,000%, and Dogecoin, which is up about 3,000%, compared to a 580% gain for Bitcoin over the same period.

“To the extent that people are taking a long-term view of their retirement accounts, crypto could be a good fit,” Hougan asserts.

What other risks are there?

As with many early-stage technologies, cryptocurrency faces unknowns and risks that make its prices volatile. The potential applications of blockchain technology – from supply chain management to banking – are undeniable, but the speed and scale of the technology’s adoption will only be known for years.

There is also a risk of criminal activity, including theft and hacks. The short history of cryptocurrency is full of cases of cyberattacks that resulted in millions of dollars in losses.

And the recent crackdown on crypto mining and trading in China, and outright bans in several countries, show that regulation could be a significant source of risk.

Nonetheless, retirement account cybercrime risk can be mitigated by ensuring plan custodians and exchanges have the necessary safeguards and regulatory approvals in place. Meanwhile, diversification can protect against volatility.

“Some core belief that blockchain will transform how global financial markets work should be enough to get investors excited about the reward-risk proposition,” says Bergman.

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