By Dr. James M. Dahle, WCI Founder
I am often asked investing questions that require a working crystal ball to answer. Since mine has always been cloudy, I usually refocus the questioner on designing an investment plan that will work given a wide range of potential future scenarios. However, there are occasionally times when the clouds in my ball clear a bit and the future becomes a little more obvious. Perhaps the reason for this is my knowledge of financial history — I've seen this movie before and I know how it ends. Such was the case in late 2017 and early 2018 with regards to Bitcoin and similar cryptocurrencies.
My message on Bitcoin has been consistent for years ever since I first wrote about them on this blog: Cryptocurrencies are neither a necessary, nor a wise asset class to include in your portfolio. Like whole life insurance and dividend stock investing, its fans will not be dissuaded. That's okay, it's a free country and you can do whatever you like with your money.
In late 2017, Bitcoin experienced a classic mania.
Multiple Warnings Against Investing in Bitcoin
I repeatedly warned readers on the podcast, the monthly newsletter, forums, and particularly social media about the consequences of getting caught up in this. Here are some examples:
From Podcast # 35 recorded in December 2017 and posted January 2018:
Podcast # 38 recorded and posted in January 2018:
I can’t remember the last time I bought into an investment that had gone up 1000 percent in the last year and did well. It just seems like…a speculative frenzy, it feels very tulip-bulbish.
Is [Bitcoin] in a bubble? Here is Bill Bernstein’s article about whether or not it was back in October.
- Not yet the subject of conversation at social gatherings
- People aren’t quitting jobs to speculate in it
- Skeptics aren’t yet met with anger
- No extreme price projections
[00:04:36] A previous article I wrote about Bitcoin 4 years ago, essentially warning readers not to jump in to a speculative instrument after a recent run-up. Over the next year, it dropped in value by over 75%. It took two more years to recover to that previous high. However, since that time a year ago, it has gone up 1000%. I can’t help but feel that I’ve seen this movie before and I know how it ends. I don’t know WHEN it ends, but I do know HOW it ends. It certainly meets the criteria for a bubble today.
[00:06:16] The question I ask when people ask me about what they should do about Bitcoin is, “What does your written financial plan say you should do about something like bitcoin?”
[00:09:11] Should you invest in Bitcoin? If you want to invest in Bitcoin don’t do it right after it’s had this huge spike in price and don’t do it with any significant portion of your portfolio. Wait until it’s price has not been skyrocketing lately. And then if you think it’s a good long term play for your portfolio go ahead and invest a few percent in it. But I’m not going to.
From the December 2017 Monthly Newsletter:
What took several years for Tulip Mania to do has occurred in a matter of weeks with Bitcoin. There are all kinds of Bitcoin millionaires out there now and the Fear of Missing Out (FOMO) has become palpable.
I sit on the sidelines and observe with fascination. I've been reading about speculative bubbles in financial history books for years, but this is really the first one I've had personal experience with during my investing career, unless you count that silliness with real estate back in 2008 or so.
Bitcoin has gone from something that only true aficionados know about, to something regularly discussed by those on financial forums, and now to something that is in the newspaper each day and discussed in social situations.
In fact, just this week there were more requests for online quotes for Bitcoin than the Dow Jones Industrial Average and people have been searching for “How to invest in Bitcoin” more than “How to invest in gold” for a couple of months. I can't help but be reminded of Joe Kennedy's quote from 1928, “You know it's time to sell when shoeshine boys give you stock tips.”
Not big on investing in any currency, much less a cryptocurrency. The only reason they’re getting any attention at all are the crazy good returns the last little bit.
From December 12, 2017
From a forum member: HELP !!! I took out a small position in BTC and a couple other cryptocurrencies. I have already made my initial capital investment back in short order (~2 weeks). Now its just playing with house money and I can’t stop.
Even though its just small amounts, I can see this being a huge time suck going forward. I have told myself I won’t check the crypto values but its so hard to do when they are skyrocketing! I check it multiple times per day. I want to continue to focus on medicine (specialty is fun and generates income) and real estate (generates passive and generational income, and wealth) but this crypto craze has got me absolutely distracted!
My response: Yet another good reason not to “invest” in speculative instruments- the gambling addiction/time suck factor. Most good traders write down the exit criteria when they enter a position. I would suggest you do so.
From January 6th 2018:
From a forum member: I’m a recent graduate of residency who had followed bitcoin for years and began investing a little over a year ago… I took money I had made from individual stocks (think FANG) as well as profits from selling the house we bought right before residency (again, a fair amount of luck) and rolled them into BTC and ETH initially. I started buying/trading lower cap alt coins that also exploded in value and now hold a significant amount of bitcoin. Or at least a portfolio that is worth a significant amount of bitcoin as I hold a handful of non-BTC crypto (or alt coins). If BTC gets to $30k by the end of the year, I will likely be a “crypto millionaire.”
My response: If I were you I would sit down and consider the odds of whether your good fortune is primarily due to your skill or your luck. If you conclude luck, as I probably would in your situation, I would suggest you sell enough crypto that it won’t hurt your financial future if it drops by 90% next week.
From October 2017
From November 2017:
From December 2017
From January 2018:
From February 2018:
As I write this post in December 2018, Bitcoin is trading around $3,400. I understand that is around the cost to “produce” it, although apparently, that is highly variable as well. I don't post all this just to say “I told you so,” but to demonstrate the benefit of becoming financially literate. The financially literate stood on the sidelines of this classic mania. They had seen this movie before, and knew how it ended.
My critics say “You don't understand Bitcoin. Block-chain technology will change the world.” While I suspect I understand the creation process and uses of Bitcoin far better than its average purchaser, the fact remains that I don't need to understand it to know I don't want to invest in it. Here are five reasons I don't invest in Bitcoin and similar cryptocurrencies:
5 Reasons I Don't Invest in Bitcoin
#1 Bitcoin Isn't an Investment
This was summed up well by Mr. Money Mustache (emphasis his) in his January 2018 post “Why Bitcoin is Stupid.”
No, you should not invest in Bitcoin. The reason is that it’s not an investment. Just like gold, tulip bulbs, Beanie Babies, 1999 dotcoms without any hope of a product plan, “pre-construction pricing” Toronto condominiums you have no intent to occupy or rent out, and rare baseball cards are not investments.
These are all things that people have bought in the past, and driven to completely irrational prices, not because they did anything useful or produced any money and value to society, but solely because they thought they would be able to sell them to someone else for more in the future.
When you make this kind of purchase, which you should never do, you are speculating, which is not a useful activity. You’re playing a psychological, win-lose battle against other humans with money as the only objective. Even if you win some money through dumb luck, you have lost some time and life energy, which means you have lost.
Investing means buying an asset that actually creates products and services and cashflow for an extended period of time. Like a piece of a profitable business or a rentable piece of real estate. An investment is something that has intrinsic value – that is, it would be worth owning from a financial perspective, even if you could never sell it.
This seems a good place to trot out my favorite Beanie Baby Mania picture, of a couple in divorce court in 1999 dividing up their Beanie Babies.
Isn't it amazing that everyone in this picture is somehow maintaining a straight face while watching this?
At any rate, I agree with MMM that cryptocurrencies aren't investments. At best they're potentially useful future currencies. At worst, they're purely speculative instruments. I don't place either in my portfolio because they don't have an expected positive return, even on a nominal basis.
#2 Bitcoin Isn't Even a Currency
At one point (mostly while the price was rising) the number of companies who accepted it was rising, although it was never any significant percentage of companies nor a significant percentage of the revenue of those companies. In essence, the reason most of these companies agreed to accept Bitcoin was purely marketing. Bitcoin was cool so the fact that they took it meant they were cool too. It has yet to function as a currency for anyone who doesn't have something to hide.
#3 Cryptocurrency Volatility Exceeds My Risk Tolerance
In 2017 Bitcoin rose from $984 to $16,090, a >1500% return. In 2018, Bitcoin fell from $16,090 to (at time of writing) $3,533, a 78% fall. Now, 78% seems bad, but what it really means is someone who bought Bitcoin at the peak and somehow held on all year endured the following losses:
Just one of those drops would have had stock investors quivering in their boots. In 2008, the US stock market lost 37% and we're still talking about it and analyzing it 10 years later. Bitcoin has had four drops larger than that THIS YEAR ALONE. One reason I buy bonds (and diversify into real estate) is that I can't endure the volatility of a 100% stock portfolio and sleep well at night. A Bitcoin investor must be taking enough Ambien that they wake up most mornings wearing pajamas in the liquor aisle at the grocery store across town.
[Update prior to publication: As my editor prepared this post for publication in May 2019, 5 months after I wrote it, she noted that Bitcoin is now trading at $8,000, up from $4,000 just 6 weeks ago, so expect to be hearing a lot more about it in the news and at the water cooler in the coming weeks.
What changed? Nothing that I can tell, it's just an incredibly volatile speculative instrument. Upside volatility doesn't really bother investors much, but I assure you that if the price can double in 6 weeks, it can also be halved in six weeks. Can you really tolerate that kind of volatility long term? I can't.]
#4 The Cryptocurrency Markets Have More Than Their Share of Scams and Scammers
Like any new, relatively unregulated market, Bitcoin and other cryptocurrencies have attracted plenty of unsavory characters. Googling “Bitcoin Scam” returns 69 million results.
Here's a good summary of perhaps the worst of the incidents, basically the equivalent of the New York Stock Exchange going under. Even the SEC is hesitant to approve a cryptocurrency ETF. Considering what they HAVE approved, that's a pretty damning indictment. Consider some of these approved ETFs:
- Horizons Marijuana Life Sciences Index ETF
- Quincy Jones Streaming Music, Media & Entertainment ETF
- The Obesity ETF
- Global X Millennials Thematic ETF
- Buzz US Sentiment Leaders ETF (Buys stocks based on social media trends)
- ETFMG Video Game Tech ETF
- iShares MSCI Kokusai ETF (Owns everything but Japan)
- RECAX (54%)
- AMUAX (27%)
- RHYAX (26%)
- MBPHX (12%)
- AXAIX (12%)
Makes 2% seem downright cheap, doesn't it? But my point is that the SEC is hardly some unassailable bastion of investor protection. If they're hesitant to approve an ETF that invests in an asset class, you should be hesitant about investing in it too!
#5 I Don't Need to Speculate to Reach My Goals
Finally, I don't invest in Bitcoin because I don't need to and if you're typical of my readership, neither do you. Don't take risks you don't need to take. Stop playing when you win the game. There are no called strikes in investing. You don't have to invest in everything.
Remember the purpose of investing—to reach your financial goals while taking as little risk as possible. Viewed through that lens, “investing” in Bitcoin or any other cryptocurrency is, just like MMM says, stupid. Don't be stupid.
What do you think? What impressed you most about the rise and fall of Bitcoin? Tell us your Bitcoin successes and failures. Why do you think so many people get sucked into what should be an obvious mania? Comment below!