Diamond Hands And Financial Plans: Betterment’s Advice For Investing In Crypto
Is there a way to invest in cryptocurrencies responsibly? We certainly think so. Here are five tips to help guide you through the process.
Even though cryptocurrencies have only been around for a short period of time, it’s abundantly clear that they’re here to stay. As a financial advisor, we at Betterment want to share our guidance on how to invest responsibly in cryptocurrency, if that’s something you choose to do.
Fortunately, Betterment has a set of five universal investing principles that serve as a guide for the investment advice we give our 600,000+ customers, and that can help you make educated decisions about cryptocurrency yourself.
1. Make a personalized plan.
As an investor, you have your own unique goals and values. Depending on those goals and values, the role cryptocurrency plays in your overall financial plan—if it has a role at all—will vary.
Let’s start with your personal values. Many individuals are fans of cryptocurrency for reasons beyond just the potential to see their net worth go “to the moon.” You may be fascinated with crypto from an engineering perspective, or maybe for the societal impact it could have.
Ultimately, it’s okay to invest your money in a way that reflects your personal values; just do so in an informed, principled manner.
The second component of personalization is your financial goals. Your goals will also affect if and how cryptocurrency should be implemented into your portfolio.
For example, if your child is going to college next year, their tuition money likely shouldn’t be invested 100% in Dogecoin. The volatility is far too large for a goal so short-term. Likewise, your emergency fund shouldn’t be held in Bitcoin either, because of the large price swings it’s experienced over the past few years.
But, if you have a play account on the side, or a long-term goal where you’re able to tolerate more ups/downs, cryptocurrency may be an appropriate component of your portfolio.
The overall point is that, just like any other investment, there is no one-size-fits-all answer: The best financial advice incorporates the unique goals and values of each person.
2. Diversify your investments.
Even if cryptocurrency as an asset class may be here to stay, it’s impossible to know which cryptocurrencies will thrive and which will go extinct. There are currently over 4,000 unique cryptocurrencies, with new coins popping up seemingly every week. It’s likely many, if not most, will fail.
With any type of investment, it’s not wise to “put all your eggs in one basket.” That’s why diversification is a critical piece of any financial plan.
In early 2021, the cryptocurrency market as a whole passed $1 trillion for the first time. That’s quite an accomplishment. But when compared to the size of the global stock and bond markets, we see just how new and small cryptocurrency is.
All the cryptocurrencies combined total just about 0.5% of the global stock and bonds markets, which exceed $200 trillion.
Global Market Capitalization of Stocks, Bonds & Cryptocurrency
If you take a market capitalization approach, crypto would make up about 0.5% of your overall portfolio. Even if you are very bullish on crypto, Betterment doesn’t recommend it exceeding a maximum of 10% of your portfolio. We also recommend diversifying across multiple cryptocurrencies.
3. Prepare your taxes.
Tax management is part of any investment strategy. Afterall, it’s not what you earn, but what you keep.
When it comes to the taxation of cryptocurrency, the word that best describes it is “confusing.” If you’re going to invest in crypto, be sure to comply with all relevant laws and reporting requirements.
The IRS published an FAQ page that addresses most common questions, such as:
- How is virtual currency treated for Federal income tax purposes?
- Will I recognize a gain or loss when I sell my virtual currency?
- Where do I report my capital gain or loss for virtual currency?
If you invest in crypto, one strategy you may consider to manage taxes is tax loss harvesting.
Betterment implements this strategy at the flip of a switch for our investment customers and we’ve automated the process so that our customers don’t have to do it manually. For example, losses that Betterment harvests can be used to offset gains in your cryptocurrency investments.
4. Weigh the overall costs and value.
With all the hype and talk of double-digit—even triple-digit—growth in the world of cryptocurrencies, it’s easy to forget about the potential costs incurred from investing in them.
Costs, when taken holistically, not only include how much you pay out of pocket, but also the execution quality of your trades, and the opportunity cost of your time.
Depending on where you buy and sell cryptocurrency, you could pay transaction fees of over 1% for each trade. Newer cryptocurrencies, or those that don’t trade very frequently, may have larger bid-ask spreads. This means the price for which you can sell your cryptocurrency is lower than what it would cost you to purchase more.
Lastly, when there are large price swings, you also must be careful about order execution. All of these direct or indirect costs can chip away at your take-home returns from trading cryptocurrency.
5. Grow investing discipline.
Warren Buffet is famous for saying the market is “a device for transferring money from the impatient to the patient." He was referring to the stock market, but the saying also applies to the cryptocurrency market.
Almost all investments have ups and downs, and the cryptocurrency market is no different. Bitcoin lost 80% of its value in 2018, over 1,000 currencies have failed, and stories of fraud are not hard to come across. These challenges -- price shocks, bankruptcy, panic, theft -- are not unique to crypto; however the risks are magnified because of the new technology, lack of regulation, and intense media hype around the cryptocurrency market.
You must be willing to HODL, even when your portfolio is dropping. As an asset class, cryptocurrencies are extremely volatile, and it’ll likely be the disciplined investors who’ll be rewarded. Before you purchase any crypto, make sure doing so is appropriate for your risk tolerance, and that you have a plan in place for if and when you encounter volatility.
Manage your investments purposefully.
Cryptocurrency is a novel type of investment, and carries a lot of risk. That’s why having a clear set of investing principles is important. These principles can help guide your investment decisions and help you avoid getting caught up in the news hype of particular cryptocurrencies.