Tickle Me Elmo, Troll dolls, Pokemon Go, Fidget Spinners. What do these things have in common? They were fads that caused an uproar then died away just as quickly.
Many times we can spot a passing trend a mile away, but sometimes–especially with kids–it’s easy to get caught up in the excitement and give in. When that happens, we can usually just laugh it off. It probably didn’t cost us much and we can get over the 10+ fidget spinners in various colors littered around the house (speaking from experience).
But you wouldn’t be laughing if you fell for a financial fad that kills your future financial dreams. The latest financial trend to take our world by storm is that of cryptocurrency. If the term itself sounds cryptic (sorry, I couldn’t resist a good pun), here’s a breakdown.
If you’re confused by all these technical terms, you’re not alone. The currency and its network are not well understood by experts or regular investors.
Encryption + Currency = cryptocurrency. Cryptocurrencies are a completely digital form of money that has gone wild lately. Emphasis on digital – it’s not physical like dollars in your wallet that you can conveniently use anywhere. You’re probably most familiar with Bitcoin, which was introduced in 2009 as the first cryptocurrency, but there are now over a thirteen hundred competitors. Yes, 1,300+ cryptocurrencies. *Hint, when you see this kind of over-the-top competition in such a short period of time, the world bubble should automatically pop in your head. Stay away from bubbles–unless you are playing with your kids.
Since mid-September, the price of one Bitcoin has exploded from about $3,300 to nearly $17,000.1 Did you do the math? That’s an unbelievable 415 percent return in a mere three months. Roll back the calendar to January and there has been a 2,000 percent return.
Count yourself in, right?
Not So Fast
Why isn’t everyone and their dog investing their life savings in cryptocurrency? It all comes down to risk.
Cryptocurrency hasn’t been around long enough for anyone to know whether it’s safe. Unlike our physical cash, cryptocurrency is not backed by a government institution like the U.S. Federal Reserve. Even if you are a rebel who doesn’t trust the government or wants to do things more “organically,” you should be concerned by the red flags surrounding stability and supply and demand. Not all regulation is bad.
The current stats and lack of historical data put this trend in bubble territory, and bubbles are only fun until they pop.2
You know that I’m all about evidence-based investing. Why? Because it’s backed by science and it works. (Want proof? Check out Dimensional Fund Advisors website here and be sure to scroll down from the home page). Evidence-based investing ignores all the “fancy” talk out there and keeps things simple. It’s based on Nobel Prizing winning academic research, and objective thoughts about robust data analysis, repeatability and reproducibility, and formal peer reviews. Cryptocurrency investing does not fall into this category and carries three major risks:
Regulatory risk or the risk of governments banning or heavily taxing cryptocurrencies. Because bitcoin is not traceable and can be used for money laundering and funding terrorism, governments may try to stop it.
Security risk or the risk of hackers and cyber thieves stealing your cryptocurrency and leaving you without insurance or government backing. In 2014, a bitcoin exchange in Japan was forced to close down after millions of dollars of bitcoins were stolen.
Market Risk or the risk of an investment’s value falling. The price of bitcoin has gone down as much as 80% in a single day and experts expect the volatility to continue.
Fight The FOMO
It’s crazy tempting to jump on the cryptocurrency bandwagon to get rich quick, but fight the Fear Of Missing Out. Using FOMO to drive your investing decisions is not a wise path to build wealth. Investing should be boring. It should be simple. It should be based on evidence. For long-term investment success, it’s important to have a well-diversified portfolio selected for your investment goals and avoid chasing returns.
All that said, if you just can’t stand your brother-in-law bragging about his Bitcoin investment at the next kids’ birthday party you find yourself at, and you just have to dip a toe in, promise me you’ll do three things:
- Know your risk level so you don’t get too far outside your comfort zone.
- Only use “mad” money–a little money on the side you can play around with. In other words, don’t withdraw half your portfolio and invest it in Bitcoin.
- If you do come out ahead, take some of those winnings and start a Donor-Advised fund to maximize your charitable giving. Maybe the good karma will tilt the odds in your favor.
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Pathway founder and principal Greg Brown is a fee only financial advisor with broad financial planning and investing expertise. Greg’s financial advice has been featured in publications like Yahoo Finance, Bankrate, Investopedia (all articles here), Wall Street Journal, and USA Today. He holds a master’s degree from the University of Chicago and a mechanical engineering degree from Michigan State University. Prior to Pathway, Greg was a lead analyst at Morningstar and previously held engineering roles at Dell (including a US Patent).
Also published on Medium.