Should I invest in Bitcoins?
Short Answer: No.
Reason # 1: There Are No Called Strikes In Investing
Long Answer: There are a number of reasons I don't invest in Bitcoins. Let's go through them.
Warren Buffett said this in his 1999 Letter To Shareholders:
The stock market is a no-called-strike game. You don't have to swing at everything—you can wait for your pitch. The problem when you're a money manager is that your fans keep yelling, “Swing, you bum!”
There are lots of investments, new and old, being pitched to me every single day by the media, by other investors, and by financial professionals. It is important when evaluating any investment to keep in mind WHY you are investing. In my case it is to pay for future expenses like college and retirement. In order to reach those financial goals I need to save a reasonable amount and invest in it in a reasonable manner. I certainly don't have to invest in everything I see. I certainly don't need 4000% returns to reach those goals. If an investment bothers me for some reason, I just let it go right by and wait for the next fat pitch. No called strikes. A long-term perspective is the best antidote to greed and fear.
Reason # 2 Don't Invest In Stuff You Don't Understand
Bitcoins are mined by fancy computers that solve complex mathematical calculations. However, there is somehow an arbitrary limit of 21 Million of them. I have no idea why there is a limit, no idea how to buy and sell them with minimal transaction costs, and certainly no idea how to solve those math problems, with or without a fancy computer. I don't invest in things I don't understand and I don't think you should either. There may be people who actually understand the whole Bitcoin thing, but I assure you they bought theirs a long time ago and are probably the people selling them to you now.
Reason # 3 Performance Chasing Is Not A Recipe For Investing Success
I saw a Wall Street Journal article recently that said Bitcoins are up from $13.50 at the first of the year to as high as $782. All of a sudden, people are talking about Bitcoins and wondering if they should invest in them. Why do they want to invest in them? Because the price has gone up recently. That's called Buying High. Buying High seems to hang out a lot with Selling Low in my experience. You don't buy something because the price has increased a lot recently and then expect to make money on it. Ask yourself how that worked out with Dutch tulips in the 1600s, with tech stocks at the turn of the millenium and with houses in Vegas in 2006.
Now I have no idea where the price of Bitcoins will be a year from now or ten years from now. Perhaps its proponents are right that it will replace the dollar as the world's reserve currency. Perhaps it really is different this time. But I doubt it. I prefer an investing strategy that doesn't require me to predict the future to be successful. Just as I warned you to limit your investment in gold two years ago, I'm warning you now about Bitcoins. Gold went up for 3 months after my warning, then has been heading downhill ever since, losing over a third of its value from the peak. Trees don't grow to the sky and the tree in that chart to the right is looking awfully high. Performance chasing and market timing are loser's games.
[Update Prior To Publication: I wrote this in November, since that time, Bitcoins peaked at over $1200, fell to less than $600 and are now back around $700. Some performance chasers who bought them, then panicked, have already been punished by losing 50% of their investment.
Update 10/2017: Bitcoin eventually bottomed out at just over $200 in January 2015 and since that time has had a meteoric rise to over $5,800. While my crystal ball is always cloudy, it sure feels a little bubbly to me, even if it isn't a “classic bubble.“]
Reason # 4 Currencies Have An Expected Return of Zero, Before Expenses
Currencies go up and down in relationship to each other. Over the long-term, these changes cancel each other out. It is the equivalent of the speculative portion of the return on stocks. Bogle has demonstrated that stock returns come from dividends, plus dividend growth, plus a speculative return. The speculative return may be positive or negative. When price to earnings ratios are climbing, it is positive. When falling, the speculative return is negative. Over the long run, the speculative return is zero. In real estate investing, you get paid rent. From time to time, rent can be increased with inflation and that in turn increases the value of an income property. There is also a speculative return that may be positive or negative, but over the long term it is zero.
With currency investing, there are no dividends or rents. There is just the speculative return. Over the long-term, that is zero, before expenses. After expenses, the return is negative. Putting your money into investments with a negative expected return is not a recipe for success. Do people make money in currency investing? Of course. People make money at the roulette table too. But you don't see any casinos going out of business. The best way to make money in currencies is to be the casino. Find thousands of people who want to buy and sell them and charge them a small percentage every time they do so. I'm sure there are people who have “alpha” in currency trading. But the sum of alpha is always zero. For every bit of positive alpha, there is negative alpha.
I have no edge against other currency speculators. I am neither the most informed, the most talented, nor the most lucky in that market place. My alpha is highly likely to be negative. Better not to go into the casino at all. People often make the error that buying stocks, bonds, or real estate is just speculating as well. It isn't. There is a positive expected return. There is a beta. With a bond, you receive interest and then get your money back. With a stock, you share in the profits of a well-run company. With real estate, you collect rent. Yes, transaction costs suck away some of your return, but that return is there. Buying a bitcoin is the equivalent of buying a Beanie Baby. You are reliant on the Greater Fool Theory. You must find someone willing to pay even more for it than you did. That works great, until it doesn't. It's all alpha, no beta.
Reason # 5 I Can't Handle That Kind of Volatility
The Wall Street Journal article linked above notes that the standard deviation of Bitcoins is 139%. Compare that to the Stock Market's standard deviation of 13-23%, depending on who you ask. In 2008 the price of stocks were cut in half. Vast numbers of Americans sold their stocks and went to cash at market lows. I didn't. I bought more. REITs lost 78% of their value. Did I sell them? Nope, I bought more, but it bothered me to lose that much of my initial investment. What is the standard deviation of REITs? About 17%. Now, imagine the losses, however temporary they might be, that are inherent in an asset class with a standard deviation 8 TIMES as high as REITs. Can you handle that kind of volatility? I certainly can't, and I doubt most investors can.
The WSJ article recommends you either completely ignore Bitcoins or just invest a tiny amount in it. Let's say you were prescient enough to have invested a tiny amount, perhaps $1,000 in it on January 1st of this year at $13.50 and you sold it at its recent peak of $782. You now have $58K. Not exactly life-changing. Now, what is the likelihood that the price of Bitcoins increases at that rate again? Even if you double or triple your money you're not likely to be willing to invest enough of your portfolio into such a speculative investment at this point that it is really going to change your life. If you're not willing to commit at least 5% of your portfolio to an asset class, don't bother investing in it at all. I won't be buying any Bitcoins and I suggest you don't either. As a high income professional you've already won the game. You don't need to invest in speculative instruments like Bitcoins to reach all of your financial goals. Don't run risks you don't need to run.
What do you think? Do you invest in Bitcoins or other currencies? Why or why not? Comment below!