Talk about volatile.
Cryptocurrency is all the rage among some investors, whose portfolios gyrate wildly on a daily basis. The value of this investment type, which is a form of digital payment, frequently rises and falls violently on social media posts, internet chatter and sometimes, for seemingly no reason at all.
Sexy stories about investors who hit it big in crypto are making more traditional investors wonder if they should also get in the game.
NJ Advance Media asked three financial advisers what they thought about crypto and whether it has a place in an investor’s portfolio.
What is cryptocurrency?
Advisers say before you invest in cryptocurrency or any other investment, you should understand how it gets its value.
“It trades more like gold, which gets its value from what people think the value is versus the profits and growth potential of a company,” said Jeanne Kane, a certified financial planner with JFL Total Wealth Management in Boonton, who noted there are more than 5,300 different kinds of crypto today.
There is no underlying asset with cryptocurrency, she said.
“If you buy Apple stock, you know that the company makes computers, tablets and phones. The stock’s value comes from their sales, what they’re producing. That’s not the case with cryptocurrency because there is no underlying asset,” she said.
Kane said unlike traditional investments, cryptocurrency transactions and records are maintained by a decentralized network rather than a centralized authority, such as a bank or government entity.
Cryptocurrency is not FDIC-insured like your funds are at a bank, and there is no regulator like the Securities Investor Protection Corporation (SIPC), which offers some protections for stocks and bonds held at brokerage firms, she said.
So the value of your cryptocurrency investment is based on what other investors are willing to pay for it.
Should I invest in cryptocurrency?
At a minimum, those who choose to invest in crypto should have a basic understanding of what it is and what drives its value, said Claudia Mott, a certified financial planner with Epona Financial Solutions in Basking Ridge.
“This is not an investment for the faint of heart given its extremely speculative nature,” Mott said. “Trading volatile assets like this can be a full-time job and those who think this is a quick way to make a buck need to consider the time and attention that needs to be paid to an investment that can gyrate 20 to 30% because of a social media post.”
Or any other kind of public comment.
It happened again on May 12 when Musk tweeted that he would not accept Bitcoin for Tesla.
“His comment caused a selloff and drop in share values that wiped $300 billion from all cryptocurrencies in a single day,” Kane said. “Do you want a Tweet or SNL skit to boom or bust your investments?”
Michael Maye, a certified financial planner and certified public accountant with MJM Financial in Gillette, said only those with a high risk tolerance should consider buying crypto.
“This is currently a very high risk/high reward investment,” he said. “Individuals who invest in crypto need to be prepared for wild swings in the price on any given day.”
But won’t I miss out if I don’t buy in?
The fear of missing out — FOMO — can make the most rational of investors become irrational, Kane said.
“The media hypes up stories about the investors who paid off their student loans or received astronomical returns from their cryptocurrency investments,” Kane said. “Are we hearing as many stories about those individual investors who lost it all with a cryptocurrency market drop? Just because someone made money on Bitcoin or with another cryptocurrency doesn’t mean that you will too.”
Mott likened the “crypto craze” to the bubble of internet stocks that burst in 2000.
“Too many inexperienced investors think they are going to make a killing trading something they have no knowledge about,” Mott said. “More than likely it will end badly for them, and for some, it already has.”
I still want to buy. How can I do it smartly?
Advisers said if you do want to invest in cryptocurrency, have a balanced approach that looks at the big picture for your overall finances.
Mott said the price gyrations alone would argue against making cryptocurrency a significant holding in any portfolio. Also, people should not use leverage or debt “to fund an investment that could lose a great deal of it’s value and leave the investor worse off than they started,” she said.
She recommends keeping crypto out of your overall asset allocation, and use side money instead.
Kane said conservative investors should steer clear of a speculative investment like cryptocurrency.
“If you are an aggressive investor and you feel that cryptocurrency reflects your risk tolerance and fits in the speculative part of your portfolio, invest with caution,” she said. “Given its volatility, cryptocurrency should only be a very small fraction of someone’s portfolio.”
Maye said that rather than purchase individual cryptocurrencies, investors could consider Bitwise, which in 2017 introduced the first cryptocurrency index fund and now has several other offerings.
But they, too, are volatile.
For example, the Bitwise 10 Crypto Index Fund, which tracks the 10 most highly valued cryptocurrencies, lost 19% in the past month and is down 16.9% over the past three months, but is up 70.1% so far this year and has a 321% gain since its 2017 launch.
Maye said he would limit crypto exposure to 5% of your portfolio, or less, given the volatility.
What are the tax implications?
In 2014, the IRS classified virtual currencies as property and not as currency, Maye said, noting that most crypto is considered an investment asset and is subject to capital gains rules.
“A crypto sold at a gain but held for less than a year is considered short term and is taxed at a taxpayer’s ordinary income tax rate,” Maye said. “A crypto that is sold at a gain but held over one year is considered long term and taxed at long-term capital gains rates, which currently range from 0% to 20% based on the taxpayer’s income level.”
Some higher earning taxpayers might also owe an additional 3.8% surtax.
If a cryptocurrency investment is sold at a loss, it can be used to offset capital gains taxes plus up to $3,000 in ordinary income, Maye said. For federal tax purposes, unused capital losses can be carried forward to future tax years but many states, including New Jersey, don’t have a carry forward rule, he said.
And on Thursday, the Treasury Department released a report detailing IRS changes as part of the American Families Plan. If passed, the bill would require reporting of crypto transfers if they exceed $10,000.
Have you bought any crypto personally?
None of the advisers we spoke to have personally purchased any cryptocurrency.
“I am not a speculative investor and don’t wish to blow my money on something that I may not be able to trade if the platform shuts down,” Mott said.
Maye also said he hasn’t, and he has no plans to.
“I do believe crypto will be around longer term as it is an interesting technology, but no one knows what regulatory environment awaits nor which crypto will dominate longer term,” Maye said.
Kane said crypto doesn’t fit into her investment strategy.
“I’m not much of a gambler and tend to invest in mutual funds and exchange-traded funds that historically have returned on average 8 to 10%,” she said. “It may seem boring to some, but over time, it grows. Slow and steady wins my race.”
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Karin Price Mueller may be reached at KPriceMueller@NJAdvanceMedia.com.