Should You Invest in Cryptocurrencies?

A wise old man once told me, “If you can’t explain an investment, don’t invest in it.”  This was just after the passage of the Tax Reform Act of 1986.  Prior to passage, Limited Partnerships were widely structured as tax shelters for the wealthy.  With enactment of the law, they morphed more into gas and oil exploration, real estate ventures, and mining marketed to any investor.  Their structure was complex and expensive.  it was difficult to understand exactly when they might pay off.  I could not explain them, so adhering to the wisdom of that old man, my brother, I did not recommend them to clients.

As a portfolio manager for global investment firms, my brother always espoused the philosophy of investing in tangible value.  He is 13 years older than me.  I respected his experience and knowledge.  Along with value, he preached the power of expense reduction. As an institutional investor, he was paying pennies per share for big block trades.  This was back when retail investors were paying over $100 to $300 in commissions for 100 shares of stock.

Now close to retirement, I know what he would say about crypto.  The question remains, though, should you invest in cryptocurrencies?

The first question to ask is:  What do you understand about crypto? If your willingness to invest is based on Elon Musk’s endorsement, you need to take a step back.  This past January, Musk’s net worth was estimated at $185 billion.  Yes, billion with a “b”.  That makes him the richest person in the world, even beyond Jeff Bezos.  He can afford to lose a lot of money.  Can you?

So, what is a cryptocurrency? The Wikipedia definition is as follows: A cryptocurrencycrypto currency or crypto is a digital asset designed to work as a medium of exchange wherein individual coin ownership records are stored in a ledger existing in a form of computerized database using strong cryptography to secure transaction records, to control the creation of additional coins, and to verify the transfer of coin ownership. It typically does not exist in physical form (like paper money) and is typically not issued by a central authority. Cryptocurrencies typically use decentralized control as opposed to centralized digital currency and central banking systems. When a cryptocurrency is minted or created prior to issuance or issued by a single issuer, it is generally considered centralized. When implemented with decentralized control, each cryptocurrency works through distributed ledger technology, typically a blockchain, that serves as a public financial transaction database.

Now ask yourself, how much of that do you understand? If your answer is “not much”, you should probably stay away.

Assuming you understand the above definition, what are the other things to consider? I list some below:

  • Most major governments have not imposed regulations on the industry, yet. This is a major issue that bears watching.  If central banks see a rising threat from crypto, government intervention could wipe out many investors.
  • The source of value in crypto is tied up in its relative scarcity.  The original crypto, Bitcoin, has an established limit of the number of coins to be issued.  Low supply + high demand=price increases. That is where its value is derived, not the tangible value of the coin itself.
  • It is not easy buying actual cryptocurrencies. You will need to setup an account with a crypto exchange to begin trading.  Scams abound so do your due diligence.
  • There are some mutual funds trying to create a crypto index offering. Vanguard offers a fund investing in companies that are themselves investing in the blockchain, but only has $20 million invested.  Schwab offers futures trading which is not something I would suggest to most investors.

In my opinion, cryptocurrency investing is at best a speculative venture.  The risks are too high for the majority of investors to withstand.  I will continue to recommend diversified portfolios consisting of no commission, low expense ratio ETFs that are created based on the risk profiles of my clients.

There may come a time when cryptocurrencies are a legitimate portion of everyone’s portfolio.  I can say with confidence that that is not the case today.

Like last month’s article on GameStop, do not get caught up in the hype.  Invest based on value at the lowest cost possible while ensuring the ability to easily liquidate positions.

To learn how an independent, fee only advisor and a CERTIFIED FINANCIAL PLANNER™ professional can help you, please contact me.  Feel free to share with others and make suggestions for future articles: peter.oneill@fiduciamwealth.com