What You Need to Know About 401(k) Accounts With Bitcoin

More Americans will soon be able to direct 401(k) funds into bitcoin. It's important to understand the risks if you want to do it.

AccessTimeIconNov 2, 2022 at 12:30 p.m. UTC
Updated Nov 22, 2022 at 3:15 p.m. UTC

Fidelity Investments, the largest 401(k) custodian in the United States, made national news in April with the announcement it will be offering direct bitcoin (BTC) allocations in its 401(k) accounts. Social media was buzzing after the announcement because Fidelity has over $2 trillion under management in 401(k) accounts. The firm stated it would allow for bitcoin allocations of up to 20% in a client's 401(k) account. This represents a potential $400 billion of new capital that could be used to purchase bitcoin.

Bitcoin has been held in retirement accounts for a while now, either through self-directed individual retirement accounts (IRA) or self-directed 401(k)s, through investment vehicles such as the Grayscale Bitcoin Trust (GBTC) or even more recently via bitcoin futures ETFs. (Grayscale is a CoinDesk sister company.)

How are 401(k)s used?

A 401(k) account represents, for most Americans, their biggest opportunity to save for retirement. 401(k) accounts are designed to be accumulation tools, offered by employers to their employees, where participants save money and build wealth. Contributions are typically deducted automatically from a paycheck and invested into a mix of equity and bond mutual funds. In 2021, 401(k) balances reached their highest point in history. When viewed as the primary tool in retirement planning, it is important to have a strategy and to understand what assets you own and why you own them.

Traditionally, 401(k) participants use their accounts to purchase equities and bonds in a cost-effective and tax-efficient manner. Participants often use dollar cost averaging over a long period of time for their 401(k) accounts with the goal of being able to live off the income the portfolio generates via dividends and periodic withdrawals.

Bitcoin is not a cash-flowing equity

It is important to understand that bitcoin is not a stock, bitcoin does not pay a dividend nor distribute capital gains to its holders. Other cryptocurrencies may pay “income,” or a yield, generated via staking, but bitcoin does not. Many equities pay dividends to their stakeholders and bonds pay a yield to holders. Understanding why an individual would allocate funds to bitcoin, especially in an account designed for retirement income, is important.

Read more: What Is Bitcoin?

It is relatively easy to understand the concept of investing into cash-flowing equities or yield-generating bonds. The income from these traditional investments is usually reinvested, along with new cash contributions made each pay period, until the 401(k) owner retires and begins to live off the portfolio income. 401(k) participants typically use an aggressive asset allocation while young, and change asset allocation to be more conservative as they reach retirement age and begin withdrawing from the portfolio.

Bitcoin in a 401(k) as a hedge or emerging store of value

Bitcoin is seen by many as a hedge asset. Many bitcoin holders believe that it is wise, similar to an investment in precious metals, to allocate a certain percentage of one’s net worth into an asset that is not controlled by a central entity. Bitcoin is an open-source, decentralized network, and many believe it is an emerging store of value. Many people view bitcoin as an insurance-like instrument that will protect their wealth in the event of a systemic failure. An allocation to an asset seen as a store of value and a hedge against governmental or central bank errors represents a responsible and reasonable approach.

Other investors believe bitcoin is an emerging technology that will power the future of many industries. An allocation to bitcoin viewed through the lens of an emerging technology would be similar to an allocation to a growth stock position or a more specific equity strategy. Many 401(k) plans offer participants the opportunity to invest in broad-based index funds or more specific, actively managed funds that may include large-cap growth or small-cap growth company stocks. Viewing bitcoin as an investment into emerging technology is a responsible way to view the asset.

It is important to note that an allocation to bitcoin represents an alternative allocation and must be done with caution.

Develop an investment thesis and portfolio rules

Before allocating funds to bitcoin in a 401(k) or IRA, investors must determine why they want to make such a unique allocation. Allocating to bitcoin solely because one believes the price may rise may not be the best decision. The investor must decide why bitcoin should have a place in his or her portfolio – for example, as a market hedge or as an active allocation to an emerging technology – and then must design rules for portfolio management.

Bitcoin-invested 401(k)s and portfolio rebalancing

Typically, as an investor nears retirement, portfolio risk and volatility will decrease. This is traditionally done by lessening exposure to equities and buying more bonds. This decreases volatility protects the portfolio from too much downside market risk. When an alternative asset allocation, such as a position in bitcoin, is introduced into a portfolio, new rules must be considered to control for risk. Bitcoin is an incredibly volatile asset and, if left unmanaged, may grow to a very large position in a portfolio, raising risk and increasing volatility. During bear markets, a bitcoin position may decrease from the target allocation, which means investors must have rules that will rebalance the portfolio back to target allocations. Using a rules-based approach to 401(k) management decreases the risk that emotions will drive the portfolio allocation – which in turn, increases portfolio returns over time.

Just because bitcoin is available doesn’t mean you need it in your 401(k)

401(k)s and IRAs are very important accounts to nearly every U.S. retiree. These accounts are the best tools we have for building retirement portfolios, so the money in these accounts is extremely important to the owner’s future well-being. Allocating to a speculative asset like bitcoin just because it’s suddenly available is not a wise decision. An investor must develop an investment thesis and develop portfolio management rules when allocating to these alternative strategies.

The innovation and store of value opportunities that are seen in the crypto asset class are unprecedented, but investors must be responsible with allocations and portfolio management – especially when allocating to highly volatile assets like crypto. Investors should not treat their 401(k)s like a hedge fund or a day trading account. These retirement accounts are best used for long-term wealth accumulation and valuable tools used in preparing for future income needs. When used correctly, bitcoin may help investors accomplish these goals. However, like any other alternative asset, when used incorrectly or irresponsibly, it may harm investments for the long term and make retirement that much more difficult.

This article was originally published on Nov 2, 2022 at 12:30 p.m. UTC


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Jackson Wood

Jackson Wood is a portfolio manager at Freedom Day Solutions, where he manages the crypto strategy. He is a contributing writer for CoinDesk’s Crypto Explainer+ and the Crypto for Advisors newsletter.

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