Crypto currencies – what place do they have in your investment portfolio?

Not a week goes by where we aren’t asked for our opinion on crypto currencies. A friend recently quoted an article he read where when describing crypto currencies, it said “Everything you don’t understand about money combined with everything you don’t understand about computers” - this probably sums it up for me.

According to Professor Marco Di Maggio, fintech and cryptocurrency expert, there are over 4,000 crypto currencies with the largest and most popular of them being Bitcoin. Bitcoin peaked recently at USD$63,237 on 15th April 2021 and now stands as of 31st May at circa USD$35,000 – a fall of circa 45%.  However, even over the last 12 months it is up well over 300%. This volatility dwarfs the volatility in the stock market (what is traditionally considered a high-risk investment) – for context during the Covid crash in March 2020 the market fell peak to trough by 34% (as measured by the S&P 500).  Crypto Currency investing is not a journey for the faint hearted.

So, where do we stand?

Crypto currencies don’t have any intrinsic value, in that they don’t give you anything in return for owning them. Stock (ownership of the best companies in the world via the global stock market) gives you dividends in return for holdings, bonds give you interest and real estate generally gives you rent. Bitcoin advocates will make the argument that crypto currencies are digital gold. In relation to gold, I am reminded of Warren Buffett’s comment:

“Gold gets dug out of the ground. Then we melt it down, dig another hole, and bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their heads”

How much of your pension or investment portfolio should be in crypto currencies?

Crypto currencies make up less than 1% of the investible universe. Therefore, in a broadly diversified long -term portfolio the answer is the allocation to crypto should be near NIL. This point is echoed by professionals who are bullish on Crypto currencies. In an Evidence Based Investor article in February 2021 by Patrick Cairns it makes reference to Ric Edelman, who has been named as the top financial adviser in the US three times by Barron’s. I met Ric at a conference in the US a few years back and there is no doubt he is very credible and a giant in the US advisor community. He is very positive on Bitcoin and recently noted that:

“The stock market makes 10% in a year. Bitcoin routinely moves up or down 10% in a day. And so it has the potential for outsized returns. It is the number-one-performing asset class of the last one, three, five, and ten-year periods since inception and many people believe it’s still in its infancy. So, there’s a tremendous opportunity.’

Even he, however, warns people not to go overboard:

“There still remain massive risks: technological risks, regulatory risks. Governments could get very upset with all of this. We don’t know where it’s going to go, so we want to keep our heads about us, not over-invest, and not subject ourselves to portfolio risks that would harm our personal finances.”  How much does he suggest an investor puts into Bitcoin? No more than 1% or 2% of their portfolios.

In the same way we don’t advise clients to purchase individual shares, we do know that a lot of clients enjoy trading individual stocks and that is absolutely fine. The same could apply with clients who want to purchase small quantities of crypto currencies. The thing to remember is that the place to make these “bets” is probably not your long-term investment portfolio that should be in line with your Financial Plan.  You should also be prepared for the rollercoaster ride. 

With the current volatility, it is unlikely that Crypto currencies in their current form will become a mainstream currency. What retailers will accept payment in a currency that is this volatile? An article in the FT by Professional Roger Svensson noted that Crypto Currencies do not hold any of the 4 basic conditions to become a stable international currency. He goes on to state that when bitcoin regains its true value, the awakening could be brutal for many.

There is no doubt that Blockchain technology is a huge advance and is here to stay. How it manifests itself in digital currency and who the winners are remains to be seen. For now, I am happy to stick with traditional assets such as stocks, bonds and real estate for my pensions and investments. However, like all these things, as the facts change, we might have to change our minds.