Cryptocurrencies are extremely popular, and because I am a former financial advisor, friends and family are always asking me which ones I invest in. They're always surprised by my answer, though.
I don't invest in them. They aren't a part of my current portfolio -- and maybe won't ever be -- for these three reasons.
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1. They're complicated
Warren Buffett is quoted as saying, "Never invest in a business that you cannot understand." And that is the No. 1 reason I avoid cryptocurrencies: I don't understand how they work.
Sure, I could study them and increase my comprehension. And if I do at some point, maybe I will include them in my portfolio. But until I learn more, I probably shouldn't buy any.
You might never be an expert on crypto if you decide to invest in it. But you should understand general information, like how it trades and any commissions associated with these transactions. As well as whether it aligns with your risk tolerance.
You should also look at the historical performance for an idea of your potential best- and worst-case scenarios in any given day, month, or year. There are no guarantees they'll perform the same in the future. But they could be similar, which can help you better set your expectations about how your account could fluctuate.
2. I think they're too volatile
Stocks are considered one of the riskier traditional investments for my investment portfolio. So I don't own 100% equities because I like having some of the downside protection that safer investments like bonds give me. The volatility I would experience trading crypto is far greater, which has made me hesitant to start.
A stock market correction happens when an index loses between 10% to 20% of its value, and a crash happens when you lose 20% or more. But crashes are rare: Over the last 25 years, stocks have experienced extreme losses like this only three times. On the other hand, Bitcoin (BTC +0.65%) has experienced these types of losses three times over the last month!
And this volatility isn't unique to Bitcoin. If you bought Ether (ETH +0.41%) on May 15, 2021, it would've been worth about $4,075. Less than two months later, it was slightly more than half that, at roughly $2,294.
If you're fine with volatility, and big moves up or down daily don't bother you, crypto might be a great fit for your portfolio. But if you find yourself biting your nails when the stock market pulls back, this type of investment may rattle your nerves even more.
3. I don't need them to meet my long-term objectives
The first thing that I do before investing is to set a goal for what the money will be used for. I have investments for things like my retirement and for the education of my children. You can win big if you invest in crypto: If you'd bought $10,000 worth of Bitcoin one year ago, you would have $36,000 today -- a 360% return. But meeting my goals doesn't require this type of increase.
Investing can grow your accounts, and as a result can help you meet your goals faster or with less money than saving alone. But this doesn't mean that you should invest in the riskiest investments to reach your final destination in the fastest time possible. And if you pick an investment that is too risky for you, it can make reaching your goals harder -- you might be constantly selling at low points to avoid further losses and buying back in at higher points. This can lead to returns that don't mirror the benchmarks of the investment that you own.
Instead, if you can start early, compounding can work its magic and grow your money over time. Between the years of 1926 and 2020, history shows that you would have earned an average of 10% annually investing in a portfolio of 100% stocks, 9% with 60% stocks and 40% bonds, and 8% with 40% stocks and 60% bonds. You can see in the table below how investing different amounts each year over a certain number of years at various rates of return could grow your accounts to around $36,000 as well -- but with considerably less risk than if you did it using Bitcoin.
| 6 years | 7 years | 8 years | |
|---|---|---|---|
| 8% | $4,500 | $3,750 | $3,100 |
| 9% | $4,250 | $3,500 | $3,000 |
| 10% | $4,000 | $3,250 | $2,900 |
Calculations by author.
Investing in crypto is enticing because it could be very rewarding. But it can also result in big losses. If they are big enough, they could even prevent you from meeting future goals.
But choosing your investments based on how well they match your risk tolerance and your long-term plans (rather than what's popular) could better set you up for success.
