Russell W. Hall, CFP®

“The newspaper employed the word ‘investor’ in these instances because, in the easy language of Wall Street, everyone who buys or sells a security has become an investor, regardless of what [they buy], or for what purpose, or at what price, or whether for cash or on margin.” – Benjamin Graham in The Intelligent Investor

The Question

Should I invest in Bitcoin?

At Eclectic Associates, we’re getting asked this a lot right now. Maybe it’s not Bitcoin exactly, but Ethereum, Dogecoin or other cryptocurrencies (crypto) are on people’s minds. If you hadn’t noticed, the IRS even has a question right at the top of your tax return – “…did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?”.

It’s easy to understand the allure. After hovering well below $1,000 for many years, Bitcoin is now up to over $55,000 at the time of writing. Stories abound of the lucky few who got in early and are now worth millions, some who are now buying up non-fungible tokens (NFTs – we’ll address those another time). Articles are asking if cryptocurrency’s rise means the end of the dollar and other currencies as we know them.

The Wrong Word

Let’s start with the word invest, which we think is being used incorrectly.

Over the years many well-known authors and researchers have tried to define the difference between investing and speculation. The famous investor and author Benjamin Graham wrestled with this question, and we largely hold to his definition that speculation is “anticipating and profiting from market fluctuations” (i.e. short-term) while investment is “acquiring and holding suitable securities at suitable prices” (long-term).

It’s that last part of Graham’s definition that really stands out. How do I know if I’m paying a “suitable” price for an investment? If it’s equity or fixed income, there are multiple ways to calculate if a value is reasonable. Although there are proponents and critics of each of those methods, what’s not in dispute is that the price you pay affects the return you’re going to get. A company may be growing at 80% per year, but if their stock is priced as if growth will be 150% per year, then an investor buying at that price will probably ultimately receive disappointing returns and even losses.

Speculation

Cryptocurrency does not have a similar evaluation method available. How do we know how much one Bitcoin should be worth? It does not pay interest, and it doesn’t even have physical value like gold or other commodities, which are already notoriously hard to value.

Some investors are supposedly buying Bitcoin to own the underlying blockchain technology, without understanding that no one has those exclusive rights. They also cannot answer how exactly crypto will replace other currencies, when those are backed by entire countries – with armies to back them up, as one of our advisors likes to put it.  And if those countries decide to crack down on using crypto, as India is proposing (or decide to issue their own cryptocurrency, like China), that could have a severe effect on values.

At the end of the day, crypto is only worth what someone will pay for it. If you are purchasing Bitcoin, you are hopeful there will be a next buyer willing to pay a higher price. That’s called the Greater Fool theory, and it has been behind many speculations and manias over the years.

With that in mind, we would reword the question: Should I speculate in Bitcoin?

The Answer

When it comes to speculating, our answer is always the same… NO.

Just kidding – that’s way too simplistic. But you should think of it like other speculative acts, including putting money into a slot machine or betting on a horse race. If you’re really interested and have money that you are willing to lose completely that won’t affect your financial well-being and retirement, then by all means go ahead. Keep it a small percentage of your investments, and don’t be surprised to see huge fluctuations up and down.

Also, remember how we said that the IRS is interested in cryptocurrency too? They treat crypto like an investment, not a currency, for tax purposes.  Selling crypto that’s gone up in value will incur short or long-term capital gains taxes, so that’s something to keep in mind.

If you’re considering buying crypto or other investments and are unsure how that would fit into your overall investment plan, we’re happy to discuss it with you. Schedule a 15-minute discovery call with a fee-only financial advisor.