Bitcoin, Ethereum, Dogecoin: What to know before investing in crypto
From Dogecoin to Bitcoin to Coinbase, cryptocurrency is the hottest trend in investing right now. Here’s what you need to know before buying in.
At its fundamental level, the objective of investing money today is to one day in the future receive a greater amount of capital, or return, on that initial outlay. The future could include plans to make a big purchase like a car or a house, but usually it is for retirement. Investors need to consider what assets to own in order to increase the chances of reaching their financial goals.
The opportunity set consists of stocks and bonds. But recently, a new asset class has emerged as a possible investment option. Let’s take a closer look at whether or not cryptocurrencies should be a part of your retirement plans.
Is crypto a good retirement investment?
The answer varies for everybody. Ever since the Great Recession ended in 2009, investors have had to deal with a historically low interest rate environment, making the search for yield a top priority. For fixed-income investors, this has been a difficult situation. But for equity investors, the easy-money policies of the past decade have resulted in the S&P 500 producing an annualized total return of 13.2% in the last 10 years. This performance easily beats the broader index’s historical return of approximately 10% per year.
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But cryptocurrencies promise even greater fortunes for those who are bold enough to follow the trend. Bitcoin and Ethereum, the world’s two most valuable digital assets, have produced trailing-five-year returns of 942% and 604%, respectively. These numbers easily trounce the S&P 500, attracting the attention of those looking to invest in the nascent asset class.
If you’re a young person who has decades before retirement, then I think it would be completely prudent to allocate some percentage of a well-diversified portfolio to cryptocurrencies. How much depends on your risk tolerance, but I’d say no more than 5%. As you become more comfortable and knowledgeable about the space, upping that allocation could be the right move. A young person can afford to take on more risk and be more aggressive thanks to an extended time horizon.
Someone close to or in retirement, on the other hand, should be much more conservative with their investment approach. In fact, I’d go so far as to suggest avoiding cryptocurrencies altogether. The reasoning is quite simple. Cryptocurrencies are incredibly volatile, as many observers know. The entire market for digital assets has lost roughly two-thirds of its value over the past eight months. Having a large sum of money invested here that you’ll need in a short period of time is probably not a smart move.
Then there’s the idea of staking your crypto or investing it in decentralized finance protocols with the intention of earning a yield, like a fixed-income instrument, on your assets. While the rates paid out to investors here can be much higher than what is typically offered in the traditional financial services industry, the risks are undoubtedly greater.
For one thing, investor protections provided by the Federal Deposit Insurance Corporation or Consumer Financial Protection Bureau are nonexistent in the crypto world. What’s more, we’re seeing today how badly things can take a turn for the worse. Troubled crypto lender Celsius just filed for Chapter 11 bankruptcy protection, and it has frozen customer accounts for almost a month due to market conditions.
Someone earlier on in their investing journey has plenty of time to recover financially should they experience a significant drawdown to their crypto assets. A retiree, however, isn’t so fortunate. Like with any financial decision-making, one must assess risk tolerance, time horizon, and annual cash expenditures. Knowing this critical information will help determine the types of investments that will be made, leading to the ultimate goal of financial freedom.
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