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Answer These 5 Questions Before Investing in Bitcoin

By Maurie Backman - May 30, 2021 at 5:36AM

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Thinking of putting some money into the popular cryptocurrency? Don't make that move until you address these important points.

These days, a growing number of people are taking the plunge and investing in cryptocurrencies. And while there are many digital currencies worth exploring, Bitcoin ( BTC -1.47% ) remains among the most popular. In fact, you may be thinking of putting some money into Bitcoin yourself. But before you do, make sure to address these key questions.

1. What's your motivation?

It's one thing to buy Bitcoin if you feel that it aligns with your overall investment strategy. Or, you may feel that adding it to your portfolio will provide you with some asset diversification, especially if, at this point, you're only invested in stocks. But if you're going to buy any cryptocurrency, you should have a specific reason for doing so. This shouldn't be one of those situations where you plunge into an investment because you keep hearing that other people are doing it.

Blue Bitcoin logo on graphic screen

Image source: Getty Images.

2. Do you understand the risks involved?

Like all cryptocurrencies, Bitcoin's price can be very volatile. And while the same can be true of stocks, Bitcoin may be more easily influenced by individual movers and shakers than the shares of well-established companies. Recently, Tesla ( TSLA -2.44% ) CEO Elon Musk tweeted that his company would no longer be accepting Bitcoin payments for its popular electric cars. That single piece of news sent the token's value on a downward spiral. And while there are comparable situations in which one piece of breaking news can clobber a stock's value, Bitcoin has greater potential to fall victim to extreme price oscillations. That doesn't mean you shouldn't buy it -- but you should be well aware of the risks before you do.

3. Have you compared it to other cryptocurrencies?

Bitcoin may be one of the more easily recognized cryptocurrencies today. But familiarity with a name doesn't automatically make it the right choice. Look into other, newer cryptocurrencies before deciding which is the best one for your investment portfolio.

4. What's your plan once you own it?

When you buy stocks, it's important to have a strategy. You may, for example, adopt the buy-and-hold approach -- load up on quality stocks and keep them in your portfolio for years or decades. Similarly, you should have a strategy for owning Bitcoin. Do you aim to hold it for a long time, ignoring its short-term moves in the hopes that it becomes a long-term store of value? Or do you regard it as a shorter-term investment that you intend to sell quickly for a profit (if you can)? Plot out your game plan before moving forward.

5. What would happen to your finances if Bitcoin were to plunge?

Much of Bitcoin's future value hinges on whether it becomes a widely accepted form of currency or not. And right now, we really don't know what its future holds. As such, if you're going to buy it, you need to be prepared for the possibility that its price might decline drastically. That may not happen, but it's a risk you need to reconcile yourself to before you invest. So ask yourself: Would losing most or all of the money you plan to put into Bitcoin stop you from retiring when you want to? Would such a crash in its value prevent you from achieving other major items on your long-term agenda, like buying a house, or paying for a child's education? These are things you ought to think through as you consider how much of your money you want to commit to any cryptocurrency. Have the answers clear in your mind before you buy.

Bitcoin could end up being not just an appropriate investment for you, but a rewarding one. Just make sure you address these questions before putting money into it.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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