Over the last few years, one of the questions I have received most often is: “should I invest in cryptocurrency?” My answer is no.
Cryptocurrency does not currently meet my criteria of an investment. It is a speculative gamble and has no place in my portfolio.
In this article, I hope to accomplish two things:
- Give a good working definition of cryptocurrency, and;
- Explain why cryptocurrency does not meet my criteria of an investment.
Let’s dive right in.
What is Cryptocurrency?
Trying to understand cryptocurrency can quickly become like getting stuck in quicksand. Just when you think you are making progress, you get dragged into an internet rabbit hole and get lost before you realize you have veered off track.
Before we decide whether to invest in cryptocurrencies, we need to define them. So here is the simplest definition I can muster. From Investopedia: “Cryptocurrency is a digital…currency.”
That’s it. Cryptocurrency is just a digital form of money.
Think of a dollar: it is a currency that can either be physical or digital. If you have a greenback in your wallet, you have a physical dollar.
But, if you have a dollar in a checking account, then you have a digital dollar. Your dollar is just a line of code in a database somewhere at your bank.
Cryptocurrency is essentially the same, except you cannot convert it directly to physical currency. To do that, you would have to convert it to another form of currency first. If you have bitcoin, you can sell it in exchange for dollars. Then, you can go to your bank and withdraw those dollars.
Following that line of thought, here are some other similarities and differences between cryptocurrency and traditional money:
Cryptocurrency Is Like Money
You can use it to buy stuff.
With traditional money you can buy stuff both physically and digitally. The number of places you can trade cryptocurrency for goods and services increases every day.
You can trade it for other types of money.
Dollars can be used to buy euros. Bitcoin can be used to buy euros.
The value can change.
A dollar is not worth what it used to be. Neither is a bitcoin.
Cryptocurrency Is (also) Not Like Money
Cryptocurrency is not required to be accepted by law.
Every business in the US is required (by law) to accept the US dollar in payment for goods and services. Nobody is required to accept bitcoin.
The value of cryptocurrency often changes dramatically.
Inflation makes the US dollar worth a little bit less every year. In 2018, inflation in the US was around 2%. That means that at the end of 2018, a dollar would only buy about 98% of what it would have been able to buy at the end of 2017.
A single bitcoin was worth almost $14,000 at the beginning of 2018. At the beginning of 2019, it was worth $3,700. That’s a loss of almost 75%. (By May 15th, bitcoin was back up to $8,000… more than doubling since the beginning of the year)
Now that you know what cryptocurrency is, I can tell you what my criteria are for including an investment in my portfolio. And, then you will understand why cryptocurrency has no place in my investment strategy.
Criteria For Investments
Safe & Regulated
First, any investment that goes into my portfolio has to be reasonably protected from bad guys. Traditional investments like stocks, bonds, and mutual funds have a bunch of rules about who can make trades and when. There are whole government agencies dedicated to watching out for cheaters. They are trying to make the system fair for everyone who participates.
Cryptocurrency does not have any of that. No one is watching for cheaters. Insider trading is allowed. Digital currency is stolen all the time.
Second, you can lose your cryptocurrency even without the help of criminals.
You need a password to access your cryptocurrency. If you forget your traditional bank password, you can contact your bank and get it reset. If you lose your cryptocurrency credentials, it is like misplacing a briefcase full of cash. When it’s gone, it’s gone.
Fill a Strategic Need
If you have read my book, you know that my investment portfolio has exactly five holdings: a Large Cap Stock Index Fund, a Mid Cap Stock Index Fund, an International Stock Index Fund, a High Yield Bond Mutual Fund, and an Investment Grade Corporate Bond Mutual Fund.
Each investment adds a unique mix of growth potential, volatility, stability, and income. As a result, each fund performs slightly differently than the others in each type of market conditions.
I start each quarter by putting my portfolio into balance according to my risk tolerance. Then, I wait for three months and allow each investment to perform differently. At the beginning of the next quarter I make whatever trades are necessary to get the portfolio back into its original allocation.
There are two reasons cryptocurrencies do not fit into my strategy:
- The values swing too violently for my taste. I am not prepared to lose 75% of the value of any part of my portfolio, and;
- Dividend income is a significant part of my investment strategy that allows me to “win” in any market conditions. Cryptocurrencies do not pay dividends.
It is true that no one can predict stock prices. However, there are significant trends that have emerged over time that continue to repeat themselves over and over. A few examples are:
- Stock prices tend to rise in good economic times and decline in and around recessions;
- The share prices of larger companies are generally less volatile than small companies, and;
- Bond prices rise when interest rates decrease.
Cryptocurrencies are too new and under-researched for us to really understand how they generally perform over time. We do not know how they interact and react to different types of economic conditions. Future regulatory environments are a complete mystery, and we have no idea how cryptocurrency will react when the laws change. We do not even know if future regulatory environments will allow cryptocurrencies.
I work hard for my money. When it comes time to invest my money, my goal is to have it work hard for me. I want a well-thought-out investing strategy to make sure that I can be a successful investor in all market conditions.
I do not gamble with my investment money. If you want to gamble, you can go to Vegas. Or you can buy crypto.
There has been a lot of media buzz around cryptocurrency in the last few years. It is an exciting new development in the world of finance, and it will likely have a significant impact on personal and corporate finance going forward.
However, I am not ready to risk my hard earned money on investing in cryptocurrency… yet.
Today, it is too unregulated, too volatile, and too unpredictable to earn a place in my portfolio. If that all changes, then I will revisit crypto. Until then, it will continue to be a speculative bet, not a prudent investment.
I hope this has been helpful! I welcome your comments with your thoughts and questions.