Bitcoin in Your 401(k)? Not So Fast, Financial Advisors Say

Millions of retirement savers may soon be able to invest in Bitcoin as easily as they now buy stocks and bonds, following an announcement last week from Fidelity Investments, the nation's largest retirement-plan provider, that it will add cryptocurrency as an option to the 401(k) plans it offers companies later this year.

"This will be remembered as a seminal moment in the evolution of crypto," says financial advisor Ric Edelman, founder of the Digital Assets Council of Financial Professionals and author of The Truth About Crypto. "For the average American worker, their only place to save for retirement is through a company retirement plan. Millions of workers will now start to buy Bitcoin who never would have otherwise."

Just because you can buy cryptocurrency in your retirement plan—whether in the future via your 401(k) or currently through an IRA—doesn't mean you should. While investing in Bitcoin, Ethereum and other digital currencies can help diversify your savings and possibly hedge against inflation and boost overall returns, financial advisors say anything more than a small stake is too risky for a long-term goal like retirement given how wild the price swings can be.

The trick is to find that sweet spot.

Even before Fidelity's decision to add Bitcoin to its 401(k) menu, interest in investing in crypto for retirement had been rising sharply, especially among younger savers. A survey last month by Investopedia, for example, found that one in four millennials say they are relying on crypto to help fund their retirement.

If you're among those interested in adding digital currencies to your long-term savings, here's what you need to know to get the biggest bang for your investing buck without blowing up your chances for a comfortable retirement.

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An employee demonstrates how the Bitcoin ATM works at the BitBase Store on August 9, 2021 in Palma de Mallorca, Spain. (Photo by Carlos Alvarez/Getty Images) Carlos Alvarez/Getty Images

Expect Turbulence

Only a quarter of Americans feel they have strong knowledge of digital assets, like cryptocurrencies, and even fewer (16 percent) have actually invested in or used digital assets before, according to surveys from Investopedia and the Pew Research Center, respectively. That unfamiliarity was one of the top reasons the Department of Labor warned the retirement industry in March to use extreme care when offering crypto investment opportunities, as Fidelity will be doing, since inexperienced investors are likely to underestimate just how volatile it is.

Of the investment firm's decision to offer Bitcoin to the 23,000 companies who rely on its retirement services, Ali Khawar, acting assistant secretary of the DOL's Employee Benefits Security Administration, flatly told the Wall Street Journal, "We have grave concerns with what Fidelity has done."

Just how volatile is crypto? In the past year, Bitcoin has plunged 10 percent or more within a single day on five occasions. By contrast, the stock market, as measured by the S&P 500, has only fallen that far that fast twice in 50 years. Recently the ride has been all downhill: Bitcoin has fallen more than 40 percent since hitting a record high of $69,000 last November.

The potential rewards for those who have the stomach to hold on through the roller coaster, however, can be great. Had you invested five years ago, when Bitcoin was valued at around $1,500, for instance, you would be enjoying a 2,400 percent gain today. Stocks over that same period are up 120 percent—still a substantial increase but nothing close to the killing that investors who timed their crypto purchases perfectly could have made.

Bitcoin and other crypto assets' unstable nature is to be expected from an investment whose worth is largely determined by what other people believe it to be worth vs. any intrinsic value, experts say.

"Returns are based purely on speculation with the hope that some future buyer is willing to pay a higher price than your purchase price," says financial advisor Rob Greenman, chief growth officer at Vista Capital Partners. While all investment involves this hope, assets like stocks, bonds and real estate come with revenue streams like interest, dividends and earnings and are backed by physical goods or a government.

Crypto's short history also means there is little past data to use in predicting its movements, especially in response to different economic environments. That includes current conditions, in which interest rates are rising and inflation is high.

So if you're going to invest in crypto, you have to be prepared to suddenly lose a potentially large amount of your money, which is why advisors caution you to treat this as a speculative investment. Only put in what you can financially and emotionally handle losing.

Make It About the Mix

Nearly half of financial advisors own some Bitcoin, Edelman says. They're not buying it because they expect to reap big gains when they eventually sell, though. Rather some advisors see it as a way to reduce their investment portfolio's overall risk, despite how volatile crypto is.

That's because cryptocurrency prices haven't typically moved in tandem with changes in the value of stocks, bonds or other assets during their short history, making them a useful tool for further diversifying the investments in a retirement portfolio.

"They don't behave the same as equities, bonds, gold or commodities, so adding it into your mix of investments can increase return and lower risk," says financial advisor Jim Shagawat, a partner with AdvicePeriod.

The potential to dramatically increase your overall gains can also be high—if the timing works out, Shagawat says. In a typical retirement account with a balance that's 60 percent in stocks and 40 percent in bonds, the average one-year return is about 7 percent. If you allocate 1 percent of the stock portion of your savings to digital assets like crypto, "and there's a wave, like when Bitcoin grew 1,500 percent, the one-year total return is 22 percent," Shagawat says. "Can it go to zero, a total loss? It is possible but with the asset mix at 59/40/1 the one-year return is 6 percent."

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A visual representation of the digital cryptocurrency, Bitcoin. The price of one Bitcoin today is around $39,000 or about 40 percent less than its November 2021 record high of $69,000. Dan Kitwood/Getty Images

Of course, crypto's low correlation to stocks and bonds is not fully tested. Crypto has a short history compared to stocks and bonds and, in recent months, it has moved in the same direction as other assets as concerns over rising interest rates and inflation have grown.

Investing in Bitcoin or other digital assets through a 401(k) or retirement account can also be useful as a way to smooth out some of crypto's inherent volatility. If you're anxious about investing in crypto at a high only to see it crash tomorrow, buying small amounts at regular intervals through your retirement contributions can be a smart way to lower the risk. Because you'll purchase it at a high some weeks and at a lower price at other times, the cost will average out over time, meaning you'll feel the waves less.

Add in Small Measure

While Fidelity will allow those enrolled in its 401(k) plans to transfer up to 20 percent of their retirement savings into Bitcoin and divert 20 percent of future contributions into the currency as well, no expert that Newsweek spoke with supported staking such a large share of your savings on crypto.

Instead, many recommended far more modest positions, between 1 and 2.5 percent of the total amount you invest. At a maximum, Edelman suggests investing 5 percent of your total savings in crypto, assuming you're adding it to an otherwise well-diversified portfolio and intend to hold onto the investment for at least five years.

"The whole idea of diversification is you want to do a little bit of a whole lot of different things," says Edelman. "At a 1 percent allocation, you're not going to harm yourself if Bitcoin goes broke and it can improve your return. The risk to reward ratio is very good."

Whether you should do 1 or 5 percent, or forget about investing in crypto entirely, depends on your risk tolerance, your ability to weather a loss and whether you will periodically re-balance your investments—that is, sell some of your winners and buy more of the laggards to maintain your recommended mix of assets—should a huge gain or loss in Bitcoin throw your account out of whack.

Figuring out where you are on that scale is actually pretty simple. If you are more conservative, invest less or don't buy crypto at all. More aggressive by nature and unlikely to lose sleep or, worse yet, sell during the occasional and inevitable deep slide in digital currency prices? Then you can invest more toward the upper end of the suggested range.

As with any investment, trying to time your crypto purchases perfectly to get rich probably won't work. And that's especially true when it comes to long-term savings accounts like a 401(k). If you're looking to make a killing, a retirement plan designed to fund your older age isn't the place to do it.