After reading our first article regarding cryptocurrency, you probably want to know if I think of this class of investment options: Thumbs up or thumbs down?
Sorry. There’s no easy answer. I’ll explain.
Our First Questions: What Do We Know and What Do We Need to Know?
At Lake Road Advisors, we begin our decisions on any investment by determining a) what we already know about it and b) what do we need to know. With cryptocurrencies, I can tell you that most likely you’re already invested in at least some of the underlying fundamentals of cryptocurrency. Large stocks that are in many mutual funds – names like Anheuser- Busch, Apple, Toyota and Walmart – are leveraging blockchain technology to improve their supply chains and internal operations. More than 90 percent of publicly traded banks are investing and testing blockchain to create efficiencies in their back-office operations.
Clearly, there’s a recognition by the leaders of these large corporations that the technical advantages provided by this relatively new way of using networked computing power shouldn’t be ignored.
The Next Questions: What are the Risks and the Rewards?
The next question: What are the risks and rewards of digital currencies? If you look backward, you can see how appealing it would have been to get in on the ground floor. On July 17, 2010, in Bitcoins early days of trading, you could have bought one coin for 5 cents. In the past several months, a single Bitcoin has traded between $30,000 and $49,000. In short, a $10,000 in Bitcoin when it was first available now would be worth more than $6 billion on the low side. Stunning, right?
But hold on. As the well-known warning goes, “Past performance is not indicative of future results.” Here’s another past performance to consider: In its 11 years on the market, Bitcoin has had six bear markets of drops more than 70 percent. A $100,000 purchase of Bitcoin in December 2017 would be worth about $16,000 the following December because the price plummeted 84 percent in that time period.
In short, Bitcoin – the largest and most prominent of all the digital currencies – is extremely volatile. The others tend to be even more so.
Still, there’s another reason for investing in cryptocurrencies besides the extreme rewards, and that is their lack of correlation with the rest of the market. A balanced portfolio is designed to avoid heading all in one direction or another. Bitcoin and the rest don’t tend to go south – or north – along with other investments. They go their own way, so in that sense they add diversity to your holdings.
Should You or Shouldn’t You Invest in Digital Currencies?
If what you’ve read so hasn’t scared you away yet (and it would be perfectly understandable if it did), the first consideration would be how this investment would get you closer to your goals. Investing in the digital currency market is one of many options for each goal – buying a new house, sending kids to college, retiring – and has to be compared to alternatives for each scenario.
The second consideration is your risk tolerance. If you’re inclined to follow stocks daily and become anxious when the market declines, you probably don’t want to invest in this group of assets because of their extreme volatility.
The third consideration is risk capacity – that is, regardless of your feeling, can you take on the risk, given your financial capacity? For example, Harvard, Yale and Stanford all have endowments that are investing in digital assets. But these endowments hold billions – Harvard alone has nearly $41 billion, at last report, and also have an infinite time horizon to invest. They can set aside large amounts for cryptocurrencies because they have the risk capacity to handle losses and volatility. Most individual investors have specific time horizons for their goals and potentially taking a large, sudden loss will almost certainly take them off track.
Here’s the short answer to the question raised in the beginning of this article: Only invest what you can afford to lose completely without causing you undue worry or derailing your overall financial plan. We’ll be happy to discuss this issue and how it affects you personally and answer any further questions you have by scheduling a call, using the link below.
