Balancing Between Barrels

Vol #209: January 9th, 2025

The best beer I ever tasted was mid-morning in Peru. We’d been up since three, and won an uphill, pitch black footrace to queue for the Stairs of Death at Huayna Picchu.

Several hours past a purple tinged sunrise over the mountains, safely down in Machu, we’d earned our burgers and beers.

The second best time for a malted beverage is the one that comes after the closing bell. Starting as a market maker trainee, this became an important part of figuring it all out. The pitcher of Coors Light in a fireman’s bar went down easy, but here you learned the hard lessons of how others thought about trading, and had an emotional support group for the 49% of the time your weighted coin flip went wrong.

Juniors were just trying to figure out what the hell happened in mock. It evolved into cocksure associates busting someone’s chops for missing a trade, and ultimately grizzled vets kvetching about how the new guy in charge doesn’t know how to take risk.

Some traditions are hard to break. While the mini-fridge in my office mostly supports a crippling addiction to sparkling water, it also usually has a beer or two. (Shout out to my friends at Broken Symmetry.)

The problem is, I also keep some beer in the home kitchen. To be clear- this is not a real problem - it’s just about beer, and it can’t be much of a concern if you have some beer…

The quirk is that each of these caches of suds drains differently, independently. The process that deposits new provisions in one place or another is fairly random, I don’t have a routine time to restock. The withdrawals are also arbitrary - a few friends over quickly liquidates a pocket of inventory.

If I wanted the perfect distribution of quantity, and mix of IPAs, pilsners, and sours, it would take a lot of work. Monitoring the levels, splitting a six pack into two places - you might even be forced to drink an extra beer to eliminate tracking error!

The beer question is trivial compared to the portfolio balancing one. More of a privilege than two beer fridges, is having a couple of different pockets of money working for you. Even if you’re not an experimentation junkie like me, between 529s, HSAs, 401(k)s, and brokerage accounts, the average investor quickly starts to accumulate several different positions.

Each of these likely has their own allocation logic. I’m thirteen years away from dipping into a 529 (and we all see the tuition inflation numbers), so I’m still keeping that risk throttle forward. Hopefully I’m at least that far away from an HSA withdrawal, but life comes at you fast, so there’s a little more cash in that bucket. Those mixes are good for now, but they’ll change faster than I think.

So what is my overall market exposure? Net SPX delta pls. Calculating that is one thing, setting or achieving the optimal target is another. It matters both more and less than you think.

Many of these accounts have restrictions that limit your ability to perfectly rebalance across all barrels. You typically can’t move money out of a retirement fund because your real estate speculation went south. 529 plans only let you put in a certain amount each year. Fortunately within those gated walls, a good plan will offer you a full spectrum of risk allocations.

A good laboratory for rebalancing questions is digital assets. The price movement here is severe, and decentralized doesn’t just mean permissionless; tokens and wallets seem to spawn via rapid asexual reproduction. It’s hard enough to just keep track of what you have.

When I started working on the Digital Ten three years ago, I logged my first index print with Bitcoin at $40,379. That sounds cheap today, but by the time the quarterly rebalance arrived, the price was already down to $23,312. It only got worse from there - remember Luna and FTX?

Through those drawdowns, the overall portfolio took a hit, but the rebalancings were minor. In the nadir of the 2022 drawdown the adjustments were single digit basis points of negligible. As the ecosystem has matured (has it?) we’d expect the weightings to become more diversified. Yet Bitcoin has gone from a 62% weighting to a high of 74% last quarter.

This has faded a bit in January’s rebalance, as BTC dominance is now down to 72% of the US approved token market cap.¹ But importantly, as the price has been going up relative to other crypto, the rebalancing is also getting longer Satoshi bucks.

Market capitalization weighted indices are technically nothing special, but they have the powerful feature of consistently accumulating more of the good stuff. The top five tokens from 2022 are still in the basket, while four of the bottom five are gone. Some went up, some went down. This is as much a function of churn at the margin when you have 3 of 10 assets making up 92% of the market value.

It’s hard to believe at one time I was an APE holder, and it’s just as curious that the meme coin SHIB has replaced projects that I saw real promise in like Uniswap or Polygon. Despite my hip NFT profile pic , there’s still a lot I don’t get about the coins.

Fortunately that level of detail doesn’t matter. You’ve got beer.

The growth of $10,000 in this strategy almost perfectly matches the 3.6X increase in digital asset market cap during this time frame. There’s a small drag, because you’re allocating to coins after they’ve gone up initially, but still very much leaning into the momentum.

While we refer to owning indices as a passive buy and hold because the underlying fund/ETF is doing the rebalancing work, the true buy and do absolutely nothing strategy underperforms this rebalancing. If we’d simply kept our 2022 allocation, we’d be approximately 5% worse off, even after the management fees and transaction costs of the active portfolio.

In my other miscellaneous fridge of digital assets I made the “mistake” of splitting a one time buy between BTC and ETH. Rather than allocating roughly 70/30 according to marketcap, this even buy (assuming it was done on the exact same day) lagged the market cap weight by over 10%. Still a nice 2.9 bagger though.

These are both big and small numbers. Every little basis point counts. Compounding even an extra percent every year can be powerful. There’s the further benefit that if you’re allocated to something you can’t easily touch, you’re less likely to meddle with it.

Yet neither of these drags are particularly worth losing sleep over. In this specific example, the dominance of Bitcoin is doing most of the heavy lifting. I think in 2022 there was absolutely a discretionary argument to bias the upside in ETH. There’s also a little bit of just randomness and ease of dividing by two. That aside, in both cases the most important thing here is that you were allocated to digital assets.

Zooming out into the bigger portfolio, these numbers make even less of a difference. I typically recommend single digit percent allocations to crypto - less if you’re just getting your feet wet - so while a six figure print is fun to watch, it’s not immediately lifestyle changing.

Rebalancing allocations is important, but just like the bifurcated beer storage it has limits. Thanks to the tools I use for the Digital Ten, or the target date funds that shift your portfolio towards cash as it’s time to pay tuition bills, there are many seamless ways to keep your individual positions on track.

Whether it’s in a crypto account or a hedged equity GULL, the best way to bake in rebalancing is as part of the core strategy. Anything that isn’t native quickly develops a dozen different little hurdles.

Leverage the easy, and seek out opportunities that align with this. But don’t sweat about over-optimization. There are much more important forces at work, and ways to spend your time.

1. If you’re a US citizen, there are some limits to what kind of crypto you can buy on an exchange. Coins like BNB (Binance) and ADA (Cardano) represent roughly 3.5% and 1.5% respectively of the global market cap, but aren’t regulated here. The Digital Ten does a market cap weighting of only those available, thus giving BTC a bit more weight.