Cryptocurrencies Do Not Belong in Your Retirement Portfolio
On October 18, 2021, the first U.S. bitcoin-linked ETF (ticker: BITO) created by ProShares began trading, making trading access to cryptocurrency “investing” easier and more readily available to everyday investors. BITO will likely not be the last product created by fund companies to capitalize on strong investor interest in cryptocurrency investing, driven by vast media attention and wildly volatile movements. This all begs the question: Do cryptocurrency or cryptocurrency-based investments belong in a retiree’s investment portfolio?
Cryptocurrencies Are Not Investment Assets
The short answer is NO. Ignoring the fact that BITO carries an expense ratio of 0.95% and the inherent tracking error problems of using futures contracts to track an index, there is a more fundamental reason why these “assets” do not belong in any portfolio. Bitcoin, and other cryptocurrencies, are not investments.
For an asset to be considered an investment, the asset must have an expected real return. A real return is the portion of return that exceeds the rate of Inflation. If an asset class cannot contribute to the real return of a portfolio over time, it makes no sense to add that asset class.
Cryptocurrencies do not have an expected real return because they are not income-producing assets. They do not represent claims on a stream of income and therefore cannot be valued or expected to grow in value (based on income growth). The “value” of a cryptocurrency is determined by supply and demand factors of an unstable and unpredictable group of market participants. Cryptocurrencies may be non-correlated assets with tons of volatility, but they do not have an expected real rate of return and, therefore, should not be considered investments and should certainly not earn a place in your investment portfolio.
Aren’t Cryptocurrencies Alternative Forms of Currency?
Technically cryptocurrencies are an alternative form of currency because some people are willing to hold them as such, but they do not even come close to possessing the qualities needed to be considered an acceptable or strong currency. A strong currency holds value stable. Cryptocurrencies swing wildly in value based on the supply and demand factors of speculating market participants. Traditional fiat currencies like the U.S. dollar are backed by their respective government’s ability to tax their citizens. Cryptocurrencies have no such backing. There is also no FDIC insurance like there is with U.S. dollars on deposit with a bank.
But Couldn’t Cryptocurrency Exposure Diversify a Portfolio?
Yes, to the extent corporations find holding cryptocurrencies on their balance sheets makes sense. Having foreign currency exposure is an important part of a diversified portfolio, but we gain that exposure by investing in international developed and emerging markets companies. Currency fluctuations enhance the diversifying power of these investments. Under my investment philosophy, I would naturally gain exposure to cryptocurrencies when corporations accept these assets on their balance sheets. Except for some early adopters like Tesla, most companies would only allow these assets on their balance sheets once the market determines which cryptocurrencies prevail to become valid stable currency alternatives (if ever).
How Should I View Cryptocurrencies?
Cryptocurrencies and cryptocurrency-based investments are nothing more than popular speculation vehicles because of their wide swings in value, media attention, and a “cool” factor. As long as people continue to think there is some sort of value in these things, they could continue to climb in value. But what happens if people one day wake up and decide they are no longer willing to hold these assets. There is no backstop, and the last investor to hold these assets will ride them down to nothing because there is no government backing, and they do not represent claims on a source of income.
I don’t know if I would classify cryptocurrencies as a mania quite yet, but how is this much different than when the Dutch bid up the value of the tulip bulb to 10x the annual income of a skilled worker in the 1630’s only to have the tulip market crash suddenly. Again, the value was driven purely by the supply and demand characteristics of a speculative group of market participants. Don’t allow yourself to be the last one holding these cryptocurrency “assets.”
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