Does Cryptocurrency Fit in my Financial Plan?

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(The following post was sent to my financial advisory clients April 20, 2021.)

There is an old Wall Street legend about how Joe Kennedy, Sr., former Securities and Exchange Commission Chairman and patriarch of the Kennedy political family, sidestepped the 1929 stock market crash on a tip from his shoeshine boy—not in the way you might think though. Mr. Kennedy made a fortune by betting against the market because his shoeshine boy’s euphoric stock tips made him realize that the market was over-extended and fueled by leveraged, speculative mania from relatively unsophisticated investors.

Is Cryptocurrency a Currency?

Cryptocurrencies, including Bitcoin, have been grabbing headlines recently with their soaring returns. These novel financial technologies have caused a great deal of public interest. There are certainly interesting discussions being had in regard to cryptocurrency’s possible future role in the global economic system; however, to date, cryptocurrency has struggled to become a viable currency. The extreme volatility that cryptocurrency has delivered has limited its usefulness as either a stable currency or store of value.

Bitcoin Volatility vs. the S&P 500

It seems that some form of cryptocurrency is likely to play a significant role in future financial transactions, but which currency and which role(s)? Bitcoin has gained some traction with merchant acceptance, a core function of any currency, but will it remain the leading cryptocurrency? There are a staggering number of cryptocurrency options available—more than 6,700! (For comparison, there are roughly 3,500 public stocks available in the United States and 7,270 Taco Bell locations.)

An additional issue creating drag on crypto’s effectiveness as a currency is that, at this point, cryptocurrencies are treated as capital gains property, which means you’ll pay tax on any appreciation if you try to buy a taco with your Bitcoin!

Is Cryptocurrency an Investment?

The modern-day shoeshine boys and girls are cheering crypto’s rise and advocating it as the investment asset class of the future. Enthralled by crypto’s rise, they loudly encourage its use as a core portfolio holding. Many of these crypto cheerleaders, however, do not have significant experience or history in the investment field. As Bitcoin has shown, there certainly is the potential for price appreciation in cryptocurrencies; however, in my view, the probability of future appreciation or even the return of investment is unknown.

Why is Bitcoin at its current price level? Unlike stocks, bonds, or real estate, cryptocurrency is not backed by any assets, it is not generating earnings, and it does not pay the purchaser interest or rent. Cryptocurrency defies conventional measures of fundamental investment analysis, and It appears that its price changes are based solely upon the idea that someone will come along later and want to pay you more than the price for which you bought it. This is often referred to as “The Greater Fool Theory.”

“Consumers should be cautious when investing in such crypto-assets and should ensure they understand and can bear the risks involved with assets that have no intrinsic value.”
— U.K. Financial Conduct Authority

Is Cryptocurrency a Bubble?

It is important to remember that history is littered with examples of pricing bubbles that eventually popped, including collectibles and novelties, like tulip bulbs in Holland in the 1600s and the Beanie Babies boom and bust, or major components of the economy, such as technology stocks in the late 90s or real estate in 2008. Scarcity and soaring prices do not always indicate lasting value! Assets that have rapidly built wealth are not always effective in preserving wealth over long periods of time.

To be sure, there are prominent, sophisticated investors who view cryptocurrencies as worthwhile investments, but the combination of hot returns that are not justified by fundamental measures of earnings and asset values, and vehement promotion and defense from “True Believers” are classic indicators of a bubble.

“Those who cannot remember the past are doomed to repeat it.”
— George Santayana

Do I Need to Own Cryptocurrency to be Financially Secure or Successful?

When Peter Lynch, one of the most famous stock mutual fund managers of all time, was asked how he maintained a focused portfolio and investment discipline with all the attractive company stocks available, he responded, “You don’t have to kiss all the pretty girls.” Meaning, you don’t have to put money into every attractive opportunity to accomplish your goals.

Portfolios based on stocks, bonds, and real estate have led to financial success and generated massive wealth for centuries. Cryptocurrencies should be viewed as speculative or alternative positions and not core investments relied upon to fund future financial goals.

If your financial plan is on track and backed by a well-diversified portfolio of investments with a solid historical track record, and you are interested in the future of crypto, then you might consider buying some of these “digital poker chips” with a limited amount of your excess capital. This could put you in a position to benefit from crypto’s upside potential, but not have your future subject to crypto’s downside risk. Just as I would not advise you to take your rent money to Las Vegas, I would not advise you to put one dollar more into cryptocurrencies than you can afford to lose!

“If you really want to throw the Hail Mary, you might take 10% and put it in Bitcoin or Ethereum. But, if you do that, you have to PRETEND YOU’VE ALREADY LOST YOUR MONEY. It’s like collecting art, it’s like collecting baseball cards, it’s like collecting shoes, you know, something that’s worth what someone else is willing to pay for it. It’s a flier…”
— Mark Cuban, billionaire

Most importantly, if you’d like to discuss how cryptocurrencies could fit into your financial plan, please give me a call!