2021 is shaping up to be the Year of the Doge. At the start of the year, Dogecoin (DOGE -3.51%) was trading for around half a cent. As of this writing on May 15, its price was about 51.5 cents. Had you invested $1,000 in the canine-themed cryptocurrency on Dec. 31, 2020, it would be worth more than $95,000 as of this writing.
The past year has delivered stunning returns, not just for those who bought Dogecoin, but also those who invested in more mainstream cryptocurrency, like Bitcoin (BTC -1.76%). But Dogecoin's price is already down more than 30% from its highs. What happens if the bubble bursts? Here's what Dogecoin investors should do in a bear market.
Should Dogecoin investors worry about a bear market?
In stock market terms, a bear market is defined as a 20% drop from recent highs. Bear markets are relatively common and can happen for a number of reasons. For example, the housing market crash caused a bear market in 2008 and 2009, while COVID-19 panic caused a short-lived bear market in 2020. Historically, the stock market has always recovered from a bear market.
But don't count on Dogecoin necessarily recovering from its recent decline from its highs. A stock represents ownership in an actual company that generates revenue. Though some will lose money or even fail, most major corporations can survive even a prolonged downturn.
The only value Dogecoin has is what its holders believe it has. Its wild price run-ups have been driven almost entirely by social media, particularly Tesla CEO Elon Musk's tweets.
As of mid-2021, Dogecoin has extremely little utility. Very few merchants accept it. One reason Bitcoin appeals to investors is that the supply is limited to 21 million coins, whereas there's no limit to how much Dogecoin can be mined.
A Dogecoin bear market could happen for the same reasons as a stock market crash, i.e., investors panic over a threat to the economy, like the coronavirus.
But since Dogecoin's value is based on hype, practically anything could cause it to crash. Last week, the price of Dogecoin plummeted by more than a third after Musk called it a "hustle" while hosting SNL, then rose again after Musk tweeted about improving its transaction efficiency.
How to buy Dogecoin safely in a bear market
There's nothing wrong with betting a few bucks on your Fantasy Football league or at a slot machine. The same applies to risking a small of cash on Dogecoin. But it's essential that you stick to the following rules if you're determined to invest.
Only invest what you can afford to lose
The biggest rule of Dogecoin is that you should only buy it if you'd be OK with losing 100% of your investment. You may think you'll be able to cash out when the bubble starts to burst.
But that's what everyone else plans to do, too. When panic sets in, it's very likely that you'll have to unload your coins for way less than you paid.
Keep it separate from your investing budget
A good rule of thumb is to invest about 15% to 20% of your pre-tax income. But don't consider buying Dogecoin if you'd be using part of your investing budget -- or if you'd be cashing out of other investments to do so.
That 15% to 20% is meant to build enough retirement savings to sustain you for at least a couple decades in your later years -- and Dogecoin is still way too fickle to count as a reliable investment. If you're going to buy Dogecoin, it should come out of your budget for discretionary expenses, like dining out, vacations, and entertainment.
Don't take on debt for Dogecoin
Remember how the first rule of Dogecoin is to only invest what you can afford to lose? Well, if you take on debt to buy more Dogecoin, you may lose your principal investment and then some.
Some platforms allow you to use margin to invest in Dogecoin. Here's how it works: If you wanted to invest $5,000, you could put down $2,500 cash and then use another $2,500 of borrowed money from your broker.
If your coins double in value, you'd essentially triple your returns. The value of your investment would pop to $10,000. You'd pay back $2,500 to your broker, and then you'd have earned $5,000 on a $2,500 investment.
But margin is dangerous, especially for volatile investments, because it amplifies your losses. In the example above, it would only take a 50% loss to wipe out your entire investment. If the value of your $5,000 investment tanked to $2,500, you'd lose $1,250 of your own money, but you'd still have to pay the full $2,500 you borrowed on margin from your broker.
Investing through credit card cash advances or personal loans will also exacerbate losses because of the interest you'll pay.
The jaw-dropping returns Dogecoin has generated this year can understandably lead to some fear of missing out. But don't let that cloud your judgement. Recognize Dogecoin for what it is, which is entertainment. It's not part of a solid investment plan.