Understanding the risks of crypto

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Why it’s not an investment and an asset you don’t want your retirement savings to depend on.

Is all the hype around cryptocurrencies like Bitcoin making you wonder if you should jump into the action?

It’s easy to feel like you’re missing out on something when you look at Bitcoin’s price change over the past decade. In early January 2012, a bitcoin was trading around $ 5. By April 2021, it had hit an all-time high of $ 63,729. To put that in perspective, a $ 100 investment in bitcoin in 2012 would now be worth more than $ 1.27 million.

While numbers like this can be very exciting, it’s important to remember that this growth has been anything but fluid. There are certain risks involved in cryptography which could result in significant losses.

What is cryptography

The first thing to understand about crypto is that it was not invented to be an investment. It was designed to be a decentralized form of digital currency using a relatively new type of technology called blockchain.

Of course, then, buying cryptocurrency is not the same as buying a stock. Cryptos don’t produce any product that will generate income, nor is there a company full of talented employees making strategic decisions about future growth that fuels value.

Understand the risks

Basically, crypto is just computer code that is sold for real money. Unfortunately, this can make it very vulnerable to threats from speculation, volatility and government regulation.

1. Speculation

Bitcoin and other cryptos have made huge gains over the years, but it’s not for the same reason that stocks and bonds traditionally rise in value. This can be best summed up by financial author Larry Swedroe:

“With stocks, we can look at measures of valuation, like return on earnings. With bonds, we can use the current yield to maturity. And with assets like reinsurance or loans, for which there are decades of data, we have historical evidence to make the proper estimates. With Bitcoin, none of the previous analyzes is possible. Bitcoin is purely speculative.

Frankly speaking, the only real way to make money with crypto is to sell it for more than what you paid for it. It is a cycle that will eventually reach a breaking point. And as they say: when the music stops, you don’t want to be the one holding the bag.

2. Volatility

Despite the overall rise in value, cryptos tend to be plagued by dramatic and often violent price swings. Over the past decade, Bitcoin has crashed at least three times, losing up to 80% of its value with each cycle.

It’s not exactly the kind of asset you want your retirement savings to depend on. Investing always requires some risk to achieve growth, but there are better ways than others to optimize that risk.

When you compare this to current market conditions, stocks temporarily slumped 50% at the start of the Great Recession in 2008. However, they were able to regain their previous value after about three years and continued to rise until the events. that took place at the start of the COVID-19 pandemic.

3. Government intervention

While anonymity is seen as one of the best features of crypto, it is also quickly becoming one of its biggest drawbacks.

New government regulations are constantly being introduced to restrict or completely ban the use of crypto. When countries like Russia and China made its use illegal, values ​​plummeted.

While you can still own crypto in the United States, the IRS now has very strict rules that citizens and platforms that deal with crypto must adhere to. This includes verifying the identity of its users and tracking transactions so that profits can be taxed appropriately.

With increased intervention comes the risk that the government will try to replace crypto with a new version. The United States has publicly announced that it is seriously considering establishing its own digital currency central bank. If this happens, it’s unclear what that would mean for Bitcoin and other cryptos.

If you still want to invest …

If you truly believe that cryptocurrencies are the way of the future and prices can rise further, limit your risk by investing only a small amount of capital. Use only your discretionary income and no more than what you would consider “fun money”.

If you happen to make any gains, sell them immediately and move the funds into more stable investments. Don’t try to double down or spend more than you can afford to lose.

With Wall Street banks like Morgan Stanley starting to make crypto available to their clients, it is possible that this will become an investment option in your retirement plan in the near future. If this is the case, we recommend that you limit the encryption to a maximum of 5% of your wallet.

As the great investment guru Warren Buffett once said: Rule number one is never to lose money. Rule number two is to never forget rule number one.

Keeping a diversified portfolio is of the utmost importance, but there are many diversification options that come with much less risk than crypto and that you can rely on more.

About the Author Julianne F. Andrews, MBA, CFP®, AIF® began her career in financial planning in 1988 and co-founded Atlanta Financial Associates in 1992, merging with Mercer Advisors in 2020. She specializes in working with doctors and executives in the health sector. industry. Her passion for working with physicians stems from the fact that she has been the wife of a pediatrician for over three decades. Julie has been on Forbes ‘List of Top Women’s Wealth Advisors in the United States since 2017, as well as Forbes’ Top Wealth Advisors since 2018. You can reach her at [email protected]. Mercer Global Advisors Inc. is registered with the Securities and Exchange Commission and provides all investment related services. Mercer Advisors Inc. is the parent company of Mercer Global Advisors Inc. and is not involved in investment services. All expressions of opinion reflect the judgment of the author, are as of the date of publication and are subject to change. The information discussed is believed to be accurate but is not guaranteed or guaranteed by Mercer Advisors. Due to various factors, including changing applicable laws, the content may no longer reflect current views. Additionally, you should not assume that any discussion or information contained in this blog serves as the receipt or substitute for personalized investment advice from Mercer Advisors. Mercer Advisors is not a law firm or a licensed accounting firm and no part of the blog content should be construed as legal or accounting advice.

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