April 24, 2024
Finance

With bitcoin above $60K, does it deserve a place in your portfolio?


Bitcoin smashed past $60,000 this week for the first time since November 2021. Demand for digital currency surged so much that it even led the crypto-trading platform Coinbase to crash on Wednesday.

After the brutal crypto winter that began in 2022, bitcoin could soon shatter its previous records as investors pour money into newly created bitcoin spot ETFs or exchange-traded funds.

The price of ether, the native token of the ethereum network, also soared past $3,300 — levels not seen since April 2022 — as investors speculated that ethereum ETFs will eventually win approval from the U.S. Securities and Exchange Commission (SEC), as well.

As billions of dollars pour into bitcoin ETFs daily, is it time to get in on the party? Proceed with caution.

What’s the big deal about the new bitcoin ETFs?

Less than a year ago, 75% of Americans who’d heard of cryptocurrency said they weren’t confident in its safety or reliability, according to a Pew Research Center survey.

But the price of the world’s largest cryptocurrency began climbing again in late 2023 after a federal appeals court ruled that the SEC wrongfully rejected an application from Grayscale Investments to convert its Grayscale Bitcoin Trust into a spot bitcoin ETF. The SEC said in October that it wouldn’t appeal the court ruling.

And in January, it gave the OK to nearly a dozen new exchange-traded funds called spot bitcoin ETFs. Spot ETFs own the underlying asset — like gold, silver, or now bitcoin — and closely track its price, minus trading costs or fees.

“There have not been any ETFs like this before,” said Ric Edelman, founder of the Digital Assets Council of Financial Professionals. “There are ETFs that invest in stocks of companies that do business in the crypto industry, such as exchanges and miners, and there are ETFs that trade futures in bitcoin, which is like buying equity options instead of stocks, but until now there have not been any ETFs that directly invest in and own bitcoin.”

The SEC’s decision allows investors to get direct exposure to bitcoin without going through a crypto exchange or dealing with the headache of storage or security issues. Instead, investors can easily gain bitcoin exposure by owning shares in their brokerage accounts, including individual retirement accounts (IRAs).

“The new spot bitcoin ETFs are widely viewed as the safest from a custody perspective because the ETFs are regulated by the SEC, and they handle the safeguarding of your bitcoin for you,” Edelman said.

Does bitcoin belong in an investment portfolio?

With all the hype surrounding bitcoin, it’s understandable if you’re tempted to buy in. But there’s a lot you need to know first before you try to profit off the skyrocketing price.

It’s still a speculative asset

Bitcoin and other cryptocurrencies are speculative investments, which are assets that people put money into, hoping the price will rise rapidly. Sometimes, speculative assets are called nonproductive assets because they don’t generate any income, like interest, dividends, or earnings. Investors who buy speculative assets are typically seeking to profit off short-term price fluctuations.

“Normally, the way you think about a financial asset is you’re providing capital to the company,” said Michael Finke, a professor of wealth management who holds the Frank M. Engle Distinguished Chair in Economic Security at The American College of Financial Services. “The company uses that capital to make something, and the people buy it. That creates profit. You can value the company based on the profitability you expect in the future.”

“With bitcoin, it’s not producing anything, so the valuation is entirely speculative,” he said.

That may not seem like a big deal if you’ve been watching the price of bitcoin tick higher and higher. Who needs dividends or interest when bitcoin’s price is up 40% in two months?

You might think that the price of bitcoin can keep going up forever. After all, the stock market has a solid track record of rising over long periods of time. But keep in mind that, unlike a company whose stock you might buy, bitcoin isn’t creating a product or service that people actually use. Even as a payment method, its usage is extremely limited.

Also, much of the wealth historically generated by the stock market has come from reinvestment rather than rising stock prices. As dividends get reinvested — which usually happens automatically in most 401(k)s and many automated brokerage accounts — you’re buying more shares, allowing your money to compound and earn even more over time.

About 69% of the S&P 500 index’s total return between 1960 and 2022 came from dividends rather than price gains, according to research by Hartford Funds. Put another way, a $10,000 investment in the S&P 500 in 1960 would have been worth more than $4 million by the end of 2022. But without dividend reinvestment and compounding, the same investment would have only been worth about $641,000.

Since bitcoin and other cryptocurrencies don’t earn dividends, any returns you earn will have to come from price appreciation alone.

“People tend to get attracted to things that have gone up recently,” Finke said. “And that’s attractive to anybody who’s investing, but particularly those who tend to be more sentiment-driven investors. They see the price go up, and they think they want to be part of it. There’s always that fear of missing out.”

Bitcoin’s price remains highly volatile

Bitcoin is far more volatile than the overall stock market. That can be exciting when the price is on a tear, like the one we’ve seen in recent months.

But when times are bad, bitcoin’s price often takes a much harder fall compared to stocks. Take 2022, which was generally an awful year for stocks, with the S&P 500 plunging around 19%. In the same year, bitcoin lost over 60% of its value.

Edelman stresses that bitcoin is highly speculative, with a history of volatility, but he believes its potential makes it appropriate for a long-term portfolio, provided that investors limit it to 1% to 5%.

“The risks are high, and if it fails, a low single-digit allocation won’t cause material harm,” he said. “And thanks to the potential for outsized returns, a small allocation can have a big impact on your overall investment returns.”

It’s not the diversifier it used to be

Still, one common reason for investing in bitcoin and other cryptocurrencies is for portfolio diversification. Spreading risk across multiple asset classes can reduce your overall risk of major losses.

The relationship between stock and cryptocurrency prices has long been debated. But recent research suggests that stock and bitcoin prices are becoming more correlated, which means they’re increasingly moving in the same direction.

A 2023 working paper by the International Monetary Fund states that bitcoin and stock prices “are fairly uncorrelated before 2020, then increasingly correlated from the second half of 2020.” One potential explanation is that institutional investors are more likely to have exposure to both bitcoin and stocks.

Researchers at Georgetown University noted a growing correlation between bitcoin and the S&P 500, particularly in times of crisis. The paper states that the correlation “significantly increased during COVID, the Russian invasion of Ukraine, and the crypto winter, indicating that bitcoin failed to serve as a hedging asset during these events.”

Bitcoin probably isn’t coming to your 401(k)

Don’t expect your 401(k) administrator to start offering bitcoin anytime soon. Fidelity and a smaller administrator called FORUSALL have both been offering employers the option to let plan participants invest a small portion of their retirement money in cryptocurrency.

But Finke doesn’t expect plans will make crypto widely available to employees, even with the new bitcoin ETFs. Plan sponsors have a fiduciary duty, meaning they’re obligated to act in participants’ best interests. One of those responsibilities is to minimize the risk of substantial losses.

“Plan sponsors are very cautious, and their consultants are very cautious about adding investment options to the core menu of a plan,” Finke said.

In fact, the U.S. Department of Labor has warned 401(k) plan administrators to exercise caution before offering crypto assets in their retirement plans, noting in a March 2022 memo that it can be “extraordinarily difficult, even for expert investors, to evaluate these assets and separate the facts from the hype.”

So, should you invest in bitcoin?

Ultimately, investing in bitcoin is a personal decision, whether you’re buying ETFs or actual digital coins. If you decide to invest, you should have an already diversified portfolio of assets like index funds. You typically don’t want to invest money in speculative assets you can’t afford to lose.

Before you buy bitcoin, think about what’s motivating you: Do you believe bitcoin has potential long-term investment value? Or is it a case of FOMO or fear of missing out?

“Investors who get attracted to shiny things because they’ve gone up in value a lot recently tend to get consistently punished,” Finke said. “This recent run-up in bitcoin seems like a perfect example of a shiny object that has attracted a lot of attention from investors but may not really perform that well in the future.”



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