We’re receiving Bitcoin questions with increasing frequency. A 100+% annualized return over five years tends to generate curiosity.
Bitcoin is a fascinating, complicated, and evolving story. The internet is full of explainers, debates, and speculation. Rather than go down that rabbit hole, Bitcoin is a useful example of how we evaluate investments for our portfolios.
What Is Bitcoin
We’ll start with a brief description … brief largely because anything beyond the basics turns very complicated very fast.
Bitcoin is a digital asset. The problem with digital assets is how to verify ownership and prevent copying. Bitcoin relies on breakthrough technology that operates like a giant ledger. The ledger records transactions so that no two people can claim ownership over the same Bitcoin. As a result, Bitcoin can act as a means of exchange, like handing over a dollar.
Bitcoin is otherwise quite unlike dollars. It is decentralized; there is no authority – army, bank, or government – backing it. The Federal Reserve can create unlimited dollars; there are a finite number of Bitcoin that will ever exist. Maybe the starkest difference is that Bitcoin is volatile. Very volatile.
Blockchain Technology
Bitcoin uses an innovation called “blockchain”. Millions of computers work together to form a communal ledger that verifies and records transactions. Bitcoin aims to be a virtual or “crypto”-currency. In theory, cryptocurrencies offer a secure, borderless, anonymous, and efficient way to transact that cuts out the middlemen (banks). Blockchain appears to be a wonderful technology that may eventually yield tremendous economic and social value.
How We Approach Bitcoin
Bitcoin has been a great investment for some and may continue to be. Yet, we don’t own many potentially worthwhile investments in our portfolios, e.g. venture capital, artwork, and farmland.
As financial planners, we build portfolios to meet clients’ long-term goals. Through that lens, Bitcoin has shortcomings.
First, we prize predictability. With Bitcoin, regulation or an ascendant alternative (is Bitcoin Google or Ask Jeeves?) may wipe out its value. The specter of zero introduces too much uncertainty. Will an allocation to Bitcoin support a client’s retirement needs in 2040? Can we achieve clients’ goals without embracing Bitcoin’s uncertainty?
Second, the volatility makes it difficult to stay the course. Stocks lost a third of their value in March 2020. Yet, we know that stocks have rebounded from every crisis. March 2020s – or worse – happen to Bitcoin regularly, often due to tweets, scandals, or market manipulation. What evidence can we turn to in the throes of a downturn to fortify ourselves, let alone our clients?
Third, while we invest for the long-term, our portfolios are liquid. In little time, we can exchange our investments for cash with fairly accurate expectations for how much we’ll receive. Bitcoin trades in decentralized, unregulated markets and can be difficult to sell quickly at a reasonable price.
Fourth, Bitcoin and stocks are correlated. Even if volatile, an uncorrelated asset can reduce a portfolio’s overall volatility. It is also hugely valuable to have assets that behave differently during stock market declines. Yet, in December 2018 and March 2020, Bitcoin’s fall was steeper than the stock market.
Fifth, stocks and bonds generate current and future cash flow (dividends). Bitcoin does not. It’s difficult to evaluate an asset purely based on what demand may be. Bitcoin’s investment proposition may be like gold – a store of value even through turbulent times.
Sixth, if Bitcoin enthusiasts are right, we still expect to participate in the upside. Like Gold Rush shovel makers or 1990s tech companies, wide adoption will inspire new businesses. The most successful will become publicly-traded stocks, and indeed some already have.
Our Mindset Remains the Same
“The natural state for the value investor is one of skepticism…. However, in a world where so much innovation is happening at such a rapid pace, this mindset should be paired with a deep curiosity, openness to new ideas, and willingness to learn before forming a view.”
-Howard Marks
We’ve said it before – successful long-term investing depends on a well-considered decision-making process. The investing landscape is vast, complex, and dynamic. Without a process, investors may be constantly yanked by the latest fad.
For now, Bitcoin’s deficiencies outweigh the potential benefits to our portfolios. We remain curious and open-minded to its potential usefulness.
If you understand Bitcoin and are optimistic, we think it’s reasonable to consider purchasing some. Bitcoin is not the same as gambling, but we suggest a similar mindset – don’t risk any more than you can afford to lose.
Bitcoin is perhaps the most prominent story in a euphoric first half of 2021. The pendulum from fear to greed has swung more quickly and powerfully than any time we can recall. With fervor flying, it can feel like we’ve entered a new financial world order.
Yet, our mindset remains the same. Cryptocurrencies do not fit within our investment discipline or circle of competence. We do not know where Bitcoin’s price is headed – nor do we think anyone does. Still, count us among the curious observers.
Our portfolios are designed to support a predictable long-term income stream, for now and/or the future. Through our focus on global diversification, controlling costs, and trust in the general efficiency of markets, we believe our portfolios are well-positioned to accomplish this goal.
No matter how Bitcoin’s story unfolds, it will be an interesting study in FOMO, markets, and psychology.
